Why Do Average Investors Earn Below Average Market Returns? | Average Returns for Average Investors

When a firm examines investor behavior and market returns, they find that most people do not do as well as they might expect.The 20-year average annual return of the S&P 500 Index was 6.06% as of the 31st of December, 2021 (Source: Open). Investors in equity funds, on average, saw a return of 4.25 percent below the market average.

For What Reason Is This Happening ?

The actions of investors are typically irrational and driven by emotion.Not a good way to make sound financial choices for the future.The following is an outline of several common mistakes that regular investors make that result in a loss of capital.

  • Purchasing on the Rise : Research shows that as the stock market rises, more money is invested. If the value drops, they cash out their holdings. It's the equivalent of buying something every time its price increases, only to return it when it goes on sale and be reimbursed at the lower discount price. 
    • Since investors are acting irrationally, market returns are significantly lower than they would have been if they had invested in the stock market historically. 
    • What may lead investors to make such a bad decision? At 6%, money doubles every 12 years. You might have saved yourself a lot of time and effort by purchasing just one index fund instead of constantly switching between them in pursuit of performance.

Profits from the Stock Market, On Average | Average Returns from Past Data

  • When most people talk about the stock market, what they really mean is the standard deviation of the S&P 500 index. Simply put, the S&P 500 is an index of the 500 largest publicly traded corporations in the United States (Later, we will see Indian context as well)
  • The list is refreshed quarterly, with annual substantial revisions. Despite the fact that hundreds more stocks are traded on U.S. stock exchanges, the S&P 500 represents roughly 80% of the total stock market value, making it a reasonable estimate for the stock market index overall. 
  • It's not uncommon for annual market results to deviate widely from the long-term norm. Applying this to the years 2012-2021:
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  • In other words, the average annual return during that decade was 14.8%, but in half of those years the actual return was much different. Two of the six years produced much lower returns, and one year, 2018, resulted in losses, while four of the years offered much higher returns. 
  • Returns of above 30% were earned in two of the years, making up for years with lower returns.
  • Since the median investor only made 2.5% per year on their investments, we might assume that poor timing had a role in this under performance. 
  • Investors frequently make the mistake of executing their capital deployment or withdrawal the incorrect time.

In addition to acting on inaccurate information, investors might get into trouble when they act on their own strong convictions.When people are overly assured of their abilities, they sometimes take needless risks in search of inflated profits. While you may have good reason to believe so right now, keep in mind that information can and frequently does shift.

A Severe Case of "Fear of Missing Out" | FOMO 

  • Those who invest often herd into investment fads because of FOMO, the concern that everyone else is generating more money than they are. On the other hand, we may incorrectly conclude that everyone else is selling when we experience market instability and fail to follow suit. 
  • Either way, we can be influenced to act counter to our own best interests by the false belief that we lack access to information that others do. At times of great market volatility, including euphoria and terror, it's important to get back to basics. 
  • As long as growth and defensive plans are balanced, there should be no market-related motivation to switch. In fact, your unique situation is the only factor that should influence whether or not you update your risk profile. 
  • By sticking to this routine, both the advisor and the client can feel secure enough to weather any market storm.

Taking This Too Seriously

  • The problem is that people have a tendency to overreact, whether they've just received good news or bad. Investment choices are made based on emotion rather than logic when this happens. 
  • If you're nearing retirement age or the economy is in the dumps, for example, you may be more prone to overreact. This propensity to act irrationally with money is actually studied by academics in a whole sub field. 
  • This field of study is known as "Behavioral Finance." Behavioral finance examines and names our money-wasting mental tricks, such as selective memory and overreaction. An inflated sense of self-worth leads one to believe they are better than the norm. 
  • To put it another way, when investors are overconfident, they tend to overestimate their capacity to foresee the future. They are eager to look at historical data and believe their superior abilities will allow them to foresee future market movements.

Tips for Reducing Your Financial Risk

  • If you want to avoid being affected by your emotions when making financial decisions, hiring a financial counselor is a good idea. In that case, you should employ a methodical screening procedure to locate an appropriate advisor. 
  • One's adviser might act as a go-between when dealing with overwhelming feelings. If you handle your own money, you must keep emotions out of buy/sell decisions. In order to make better choices, think about applying the following four suggestions.
  • Simply choosing to do nothing after giving it some serious thought is an action in and of itself. Consider your cash to be a bar of soap. Hold onto your stocks through any market downturn. If your investments are in the right places, you won't ever have to sell stocks during a bear market. This is so even if you have a steady stream of cash coming in.
  • Don't sell your equity holdings during a bear market cycle in the stock market in the same way that you wouldn't rush out and post a "for sale" sign on your house the moment the housing market started going downhill.

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