The past month has been a little bumpy in the market. Since September 18th, the S&P 500 is down a little more than 6%—reminding us of a very important (although often forgotten) point:
The stock market can go both up AND down.
We’ve had a great run over the past five years, but at some point corrections do happen. What’s important is not to know when these drops will happen (which is impossible to do) but to instead expect them and think about the long-term.
Stocks versus Bonds
Any sell-off in the equity markets forces us to recall that stock prices move a whole lot more from year to year (yes, in both directions) than do bonds. There is more risk in owning stocks—which is why they move around more than bonds, and have historically returned almost 5% more per year.
Consider the chart below. The range of outcomes for stocks over a one-year time horizon varies greatly—one of the main reasons stocks have historically returned a premium to bonds. Also, notice that as the time horizon is lengthened, the range of performance is narrowed—highlighting the importance of discipline and long-term thinking.
The Average Investor
Regardless of this data, history shows that the average investor is terrible at staying disciplined and thinking about the long term. According the DALBAR, over the last twenty years, the average investor has only managed to beat inflation by 0.1% annually—trailing bonds by 3.2% and U.S. stocks by 6.7%!
Average Investing = Average Results
Not surprisingly, this behavior results in a huge gap in ending wealth. Consider the chart below, which compares the ending wealth of US Stocks and Bonds in relation to the average investor wealth—just barely beating out inflation.
Believe it or not, investor behavior has tremendous implications on your returns—often even more so than the funds themselves. Why? The average investor tends to invest money in things that have recently done well and run away from things that have done poorly of late. This is called “return chasing” and DALBAR comes to the following conclusion:
“Investment results are more dependent on investor behavior than on fund performance. Mutual fund investors who hold on to their investment are more successful than those who time the market.”
How to Avoid Average Results
If the market sell-off continues, there are a few important things to consider to avoid the fate of the “average investor”.
- Take on the “right” amount of risk for you—that you will be comfortable sticking with as the market moves up and down
- Develop and plan a strategy that you have confidence in prior to investing.
- Don’t be tempted to try and time the market. Study after study show that investors repeatedly buy and sell at the wrong time.
If the market sell-off continues, it is more important than ever to stay disciplined in your investment strategy and prioritize long-term results over short-term reactions. In this way, you can be intentional about managing your wealth, and move confidently into the future regardless of market fluctuations.
 Source: Mpi Stylus. From Jan 1926 – Jun 2014. Stocks are S&P 500 TR index and bonds are US Government Intermediate Bonds TR. 10.10% for stocks vs. 5.27% for bonds.
 Forbes.com. Fund Investors Lag As S&P 500 Nears All-Time High. http://www.forbes.com/sites/tomanderson/2013/03/28/fund-investors-lag-as-sp-500-nears-all-time/
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