Most People Are Really Bad Investors. Here Are 4 Ways to Fix It.

bad investors

Have you ever read an article or seen an image that makes such a deep impression on you that you have a hard time forgetting it? This happened to me last year.

I was reading an article about the success of regular investors like you and me. It was comparing how investors perform compared to different types of assets. For example, how does the average person’s investing success compare to the performance of energy stocks, or gold, or the S&P 500? The article was accompanied by this chart:

Average investor returns.png

See the little red box on the far right? That’s many of us--the average investor. Over the 20 years of this study, the average investor’s annual return was only about 2% per year. This is below almost every asset class in the study.

This research should shock most of us. How is it that average investors have done so poorly? Much of the failure can be credited to one word: emotion. People tend to be such poor investors because they buy or sell investments based on precisely the wrong times.

Here are four ways that are likely to make a better investor of you, and hopefully move YOUR average performance a little further up the chart.

1. Don’t try to pick stocks

The first place most investors get in trouble is they try to pick their own stocks rather than simply buying diversified, low-cost mutual funds. It’s not surprising. Many people love the “thrill of the chase” and being the one who beats the market. I’ve been there too.

As a recent college graduate, I loved investing. One of the first stocks I purchased was in 2007. It was an off-shore oil drilling company. The stock did great for a little while...until the market crashed. On top of that, the company built the oil rig which leaked millions of gallons into the Gulf of Mexico years later. The company is worth a fraction of what it used to be (please note this isn’t a recommendation to buy or sell this stock...simply an observation to illustrate my point).

Screen Shot 2017-11-01 at 8.31.44 PM.png

Sadly, this is the fate for most stock picking investors. We may pick a few winners, but our overall stock portfolio tends to significantly underperform the market.

2. Embrace boring

Investing guru Warren Buffett recently gave investing advice through his 2017 annual shareholder letter. Here it is:

“Over the years, I’ve often been asked for investment advice, and in the process of answering I’ve learned a good deal about human behavior. My regular recommendation has been a low-cost S&P 500 index fund.”

That’s it. No frills. No hot stocks. He’s given this same advice time and time again. You can see on the first chart how the S&P 500 has done over time compared to the average investor. Buffett’s point is that most of us would be far better off just sticking with a low-cost index fund than picking stocks.

3. Keep a long-term outlook

Research has shown that investors even underperform the same mutual funds they hold. This is illustrated by a recent conversation I had.

An investor called me saying he was ready to get back into the stock market. “Back into it?” I asked. “How long have you been ‘out of it?’” It turns out in the market crash of 2008 he sold all of his investments, unsure of what the market would do. Now in 2017, 9 years later with continual stock market gains, he was ready to get back in.

Our own behavior gets in the way of better performance. This investor might have been more inclined to stick with his original investments if someone reminded him that his retirement is decades away--which historically leaves ample time to ride through the ups and downs of the market.

4. Have a “Play Money” account

If you can’t fight the urge to do some stock picking yourself, there is hope for you! I encourage stock investors to have a small side account where they can trade stocks to their heart’s content.

Keep this “play money” limited to no more than 5% of your total portfolio. For example, if you currently have $100,000 saved in your 401k or IRA, allow yourself to invest $5,000 on the side. If your stock picking goes well, allow yourself to continue trading on the original principal amount plus any additional growth.

This account may very well be the only thing between some investor’s retirement accounts and financial ruin. Giving yourself a bit of investing freedom can help scratch the itch.

I hope this article has been helpful. Stock picking is tough. Not even the highly paid professionals get it right much. We should accept that in many cases, our emotions get in the way of making good investment decisions. Rather than playing to those emotions, embrace the “boring” long-term investing approach that many average families have built their wealth on. You’ll be a better investor for it.