Today's podcast episode was largely inspired by an article in TheBalance.com, titles "Why Average Investors Earn Below Market Returns." You can read it here: https://www.thebalance.com/why-average-investors-earn-below-average-market-returns-2388519
Investors often earn returns below what the market brings in. When Stacey Andres was teaching stock trading, it's something he ran into frequently. We used to call it "fear and greed," but now folks call it "behavioral finance." Essentially, the average investor is so afraid of losing money, that they often overreact to market volatility.
Michael Wallin cites a Dalbar study further showing the disparity between market returns and investor returns. Investors often perceive a loss of money when the market is down, but the money isn't actually lost until you sell the security! Recency bias often comes into play -with the belief that a down market will continue to fall, or that an up market will continue to rise.
This often leads to trailing the market by one or two percentage points a year. That may not seem like much, but it can compound over time. Stacey and his calculator show us how this turns into real money.
Our article from the balance talks about 4 ways to avoid these usual pitfalls.
Do nothing
Know that your money is like a bar of soap - the more you touch it, the less you have!
Never sell equities in a down market
Trust that the science works.
If you need help putting together a financial plan - so you can stick to it - feel free to reach out to Michael and Stacey. You can find them on our website - artofwealthunbroken.com. Or give them a call at 855-378-1806.
Jag: Welcome back into The Art of Wealth unbroken. I am Jon Jag Gay. I'm joined by Michael Wallen, and Stacey Andres. As always gentlemen, great to be with both of you.
Michael: Great to be with you too, Jag.
Stacey: Good to be here again, Jag.
Jag: So Stacey, our article we're discussing today comes from thebalanced.com and it's entitled, "Why Average Investors Earn Below Average Market Returns." And we see this all the time. When we look at the numbers, that the returns of the market are usually greater than the returns of individual investors. Why is that?
Stacey: Well, this is a very interesting topic of conversation. And when I was teaching stock trading, this is something that we struggled with all the time when talking to the students when teaching them, and it really comes down to fear and greed.
The more technical term for it nowadays is behavioral finance. It really comes down to making the wrong decision at the wrong point in time. And investors tend in markets like we're seeing today want to move to safety because they are fearful that if they stay in too long, they're going to lose too much of their money.
And they don't really have a plan for what it looks like. Long-term for them to start at one point. And look 5, 10, 15, 20 years down the road and say, what is it going to take to get me there?
Michael: To support this, you know, this article JAG, does a great job looking at research that is done by Dalbar Inc. For those that are listening, Dalbar is a company that studies investor's behavior and analyzes investor market returns.
And we know over the last 20 years, the S and P 500 has averaged just a little north of 6% a year. But the average equity investor has only realized about a 4.2, 5% average rate of return. And the reason why is, as Stacey mentioned, was the behavioral finance. It is two elements. One being loss aversion. People are very averse to losing or thinking they're actually losing money when the market actually contracts, but it's really not a loss until you actually sale. The underlying positions you have. Market gains, you have market losses, but those only come when the items are sold.
Jag: Mike, what you're saying is it's a fear of the perception of loss, as opposed to the actual loss.
There's a commercial that's out recently. I saw it on the basketball tournament. It's from a tax return from where the guy's talking about crypto. When he goes, I'm a millionaire, I'm not a millionaire, I'm a millionaire, I'm not a millionaire, and he's experiencing all that, but really it's all on paper.
And so you buy or sell the actual item.
Michael: That's absolutely right. JAG and loss aversion is causing people to make erratic behavior and also recency bias. You know, that it is leading into that to believe that whatever is the most recent action or behavior on the funds or the dollars that are being invested.
They are looking at that as that's the way it's always going to be. So if the market is contracting and you hold an underlying position and it's going down in perceived value, you believe that it's going to always continue going down. And it's just as bad on the other side, when the markets are expanding, people believe that those positions are never going to stop going up either way. It can have a detrimental effect on a person's longterm investing strategy.
Jag: The funniest thing I've heard about this lately, Michael and not funny "ha ha" but funny "odd" is people look at their investments the opposite way they look at everything else.
If you were to go buy a car or a bed or even bread in the grocery store. A low price is a good thing. You buy it when it's on sale. And if the price is sky high, you probably stay away from it. But investors tend to do the exact opposite with their investments, where they freak out when it's low and they think it's great when it's high.
Michael: It's the old cliche that investors typically sell low and they buy high, which is the opposite of what you should be doing. It's the exact opposite. You know, Warren buffet has been communicating that out into the industry for many years. And matter of fact, And Stacey can probably speak to this in detail, but what a lot of firms will do is they look at odd block trading.
And if you find that whatever, the odd lot trading time period is doing, long-term investors will do the opposite.
Jag: Speaking of Warren Buffett, Michael, he has that famous quote to be fearful when others are greedy and greedy when others are fearful. I think less experienced investors tend to be the lemmings jumping off the cliff.
If you remember the old video game, whereas Warren buffet is saying, Hey, might want to think about doing the opposite of the crowd sometimes.
Stacey: And one of the things that Michael and I were talking abou. Just pre-show here was that a way to avoid that is to have a plan, righ?. And I know it varies from advisor to advisor, but one of the ways that I look at it and what we were talking about, especially if you're moving into retirement or you're at that point, how can you avoid that emotional tug of war?
That's telling you to stay in the market or telling you to get out of the market when things get volatile and by segmenting your. Into different buckets. For example, if you have a bucket that is a one to two year plan, that is a current income stream that, you know, regardless of what's going to happen, nothing is going to affect that money.
Then you have a second bucket that maybe he's looking out two to four to maybe five years and you take a little bit more risk with that money, but regardless of what's going on there, it's not going to be significantly impacted. And that bucket will feed bucket number one. And then you have a third bucket.
That's your bucket that can be tied to the market where you can take the volatility, the highs and the lows, the ups, and the downs, because you know that regardless of what happens in that third bucket, It's not going to affect what's going on in the first two buckets, where, which are your current source of income that you might be living off of.
And so by having a system or a plan in place like that, that can balance everything out so that when we're going through the volatility that we're currently experiencing, You don't need to let it keep you up at night because you know that this is a part of the plan and that over the course of time, things are gonna work out.
And what this all kind of ties to is, there's a lot of people that want to time the market, and don't necessarily realize that it's time in the market in a lot of cases, that is the most beneficial.
Michael: The most important thing as Stacey said is to have a plan and stick to it in order to ensure that investors have both a enough financial liquidity, such as cash on hand to ride out uncertain times, as well as emotional liquidity to avoid emotional decision-making.
And because of that emotional decision-making too often, people abandon the plan that has been put in place. And it is typically, JAG, to the point of one and a half to 2% a year that individuals will trail the overall market because they will make bad decisions. They abandoned the plan because of the loss of aversion, and that can be avoided.
Jag: What's crazy there, Michael, is you're saying 1% or 2% a year, which to our listeners might not sound like a lot of money, but that one or 2% every year, you start compounding that moneyfor me, I'm probably retiring in 25 years. I'm 41 years old. That is an awful lot of money by the time, all is said and done.
Michael: It changes the way a person looks at retirement, the way that they can actually look forward to experiencing retirement because of that compounding effect that you just mentioned.
Stacey: So I'm just pulling out my calculator here and just seeing what that extra 2% would be is. Let's say you got 5% and you were looking at 20 years, you would turn a hundred thousand dollars into $265,000.
Now, if you took that same number a hundred thousand dollars over 20 years, and you got 7% instead of 5% average, that would turn it into $386,000, almost $387,000. Then you start talking those types of numbers that can significantly impact a person's lifestyle. And the way they're going to live when they reach retirement, I need to start relying on those monies to live.
Michael: And there's four areas the article really brings up that we should focus on during these types of uncertain times. Number one is to do nothing. A conscious and thoughtful decision to do nothing is still a form of action. And for a lot of people due to loss aversion, that emotional feeling that the market's contracting, and I've got to get my money out of it.
Where that can be overwhelming if they can just take a step back, breathe, talk to their advisor, or if they don't have an advisor, get an advisor that can sit down and have those discussions of looking at the long term effect. And talk through that process because doing nothing may be the best course of action.
Number two would be know that your money is like a bar of soap. And we all laughed about this as we were reading the article, but it's a famous quote by Gene Fama Jr. He's a famed economist and he stated your money is like a bar of soap. The more you handle it, the less you'll have.
Number three, never sell equities in a down market. If you're well-diversified in your strategy, as Stacey mentioned, and you've got your money put in different traunches of when you would be dependent upon them for financial liquidity, so that you have enough cash flow to be able to live off of, you should not be selling equities in a down market.
Number four, trust the science. It works. If you are working with a trusted advisor that has built you a comprehensive plan, then you should be able to look back and see how that strategy has worked historically over other times when the market has contracted,
Stacey: I think it was a year or two ago. I was reading an article by Morningstar. Actually this goes back a few years. They're doing an update on what is the safe money withdrawal rate. Cause we've all heard that it's 4%. In the study that they did, they found that for the person that uses an advisor to help them put their plan in place and keep them on track that to our point earlier on average earns 3% more over the course of their lifetime per year, not just over the course of 20 years, but on an annual year over year base.
And so as I added that up on the calculator here just a few minutes ago, you can see that really can significantly make a big difference.
Michael: Planning is the most important factor. Sitting down, understanding how you would plan your investing, but also planning your distribution so that you have a timely approach to making sure that your cashflow and mostly Stacey and JAG. I see as clients come in the office, their biggest concern is over the distribution. They get fearful of their investing strategy because they're fearful of not having the distribution of cashflow that is necessary to live the lifestyle.
They want begin with a comprehensive plan. And do not deviate unless the plan warrants, greater opportunities.
Stacey: As in business. I think that saying begin with the end in mind is a great way to think about financial planning. Where do you want to be? Because if you're going to be blown by the wind, the Bible talks about that. If you're going to be like chaff, that you're never going to get anywhere, you're never going to be successful. So beginning with the end in mind, Michael JAG, again, putting that plan in place and staying the course. Staying the course is vitally important to any sort of success in life and investing in business. Staying in the course.
Jag: You couldn't have summed it up any better, Stacey. Having a plan and staying the course is how you avoid a lot of these pitfalls that unfortunately we see so many investors fall into. If you want to know more about our show, if you want to know more about your financial future, you want to talk to Michael or Stacey, you can visit our website, artofwealthunbroken.com. And Mike, we've got a phone number for our listeners too, as well.
Michael: We do it's 855-378-1806. 855-378-1806
Jag: The plan is so important to your financial future. Number one, having the plan and then number two, sticking to it. Cannot emphasize that enough, Michael Stacey, great stuff as always. We'll talk to you next week.
Michael: Thank you, Jag.
Stacey: Thank you, Jag.v