Why The "Average" Investor Is So Bad At Investing

It's a sad truth, but the average investor is terrible at investing.

This isn't just my opinion. This is what the data says. In fact, the troubling reality is that many would be better off putting their money under their mattress and allowing their purchasing power to erode with inflation.

That may sound shocking to you, but let's take a look at the facts...

A study from Dalbar, a financial services market research firm, found that in 2018, where the S&P 500 lost some 4.4%, the average investor was down 9.4%. This wasn't a one-off year, either. Over a 30-year period, the average stock investor has generated an annualized return of 4.1%, less than half of the S&P 500's 10%.

One of the biggest factors behind such poor performance by the average investor is that emotion gets in the way. Most investors lock in gains too soon while hoping that their losers rebound. This phenomenon is called "loss aversion" in the field of behavioral economics.

Dalbar study chart

In their excellent book, "Why Smart People Make Big Money Mistakes and How To Correct Them," authors Gary Belsky and Thomas Gilovich point out that oversensitivity to losing money can also sometimes make us hold on to losing investments for longer than we should. To quote the authors:

Ask yourself if you've ever sold a stock not because you thought it was finished rising, but because you wanted to 'lock in profits.' And ask yourself how many times you've held on to a losing stock or mutual fund because you were sure it would 'come back.'

I know I talk a lot about letting your winners run and, more important, cutting your losers short, but I can't stress enough how important this is. And this Dalbar study proves exactly why.

If you want to be significantly better than the "average" investor, then stop doing what the average investor does, which is buy high, sell low, and let small losses dwarf into big losses.

Over at Maximum Profit, our system doesn't allow for a "wait for that stock to rebound so we can sell to break even" mentality. If a trade isn't working out, we cut it and move on.

Take Glu Mobile (Nasdaq: GLUU), for example. I recommended the company in a May issue. The stock was showing strong momentum – momentum that quickly vanished after it reported earnings on May 6. Investors didn't like what they heard and sold off shares. As a result, our system flashed a "sell" signal, and I sent out an alert saying that it was time to cut our losses and move on.

The sudden drop in share price gave us a loss of roughly 17%. To be sure, I hate it when that happens. We've found gains of 20%, 118%, and 266% with the Maximum Profit system, but no system is perfect.

But I'm sure glad we cut our losses when we did, because those investors who decided to wait for the stock to climb back closer to their entry price so they wouldn't have to incur a loss have seen their original investment cut in half.

GLUU chart

It's hard to realize what a 50% loss means... and what's required just to recoup the original investment. A 50% loss requires a 100% return just to break even. Triple-digit gainers aren't easy to come by. But for Maximum Profit subscribers who followed our "sell" signal, our 17% loss in GLUU requires a roughly 20% return to get our money back -- a much easier pill to swallow.

Action To Take
When the market throws a temper tantrum (like we saw on Aug. 5 where the Dow Jones Industrial Average shed more than 600 points and the S&P 500 was down more than 3% at one point), don't let emotions dictate your trades. Take a step back and think logically. Have stop-losses in place and rules to follow. Follow them. If you get stopped out of a trade, it's okay. You can always get back in. You can always find another opportunity.

In fact, my colleague Jim Fink has found an opportunity you'll definitely want to hear about...

Jim has been serving up some impressive trades for his Inner Circle members for the past few months, and for a limited time he's agreed to show 500 smart investors how his "paragon" trading system could help you earn 2,500% in just one year, guaranteed.

Go here now to learn all the details.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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