Many studies have shown that individual investors, managing their own accounts, do about 5% worse than they would if simply buying an index fund. The top investment managers have regularly beaten the averages, so it is a big spread.
The current environment illustrates all of the key reasons for this.
Psychology. Investors buy tops and sell bottoms. The front-page story in today’s Wall Street Journal illustrates the current sentiment.
Sentiment. The individual feels smart if he can talk about what is in the headlines. This approach shows no understanding of what is already “in the market.” Everyone else reads the headlines. Where is the edge? I gave key examples in this article.
Analysis. Investors do not know how to interpret economic events, nor do most of the pundits. Here are three key blunders:
- Most of the economic bloggers who are not actually economists miss the default condition — normal economic growth. They think that unless there is stimulus of one sort or another, the economy will fail.
- Most current pundits blunder about the state of the stimulus package. Only half of the money has been spent. It is not about to dry up.
- Even if there was no additional stimulus, the ongoing deficits certainly must be considered.
None of this is to say that we should not do more stimulus. That is a topic for another day.
Politics. The dialog in the investing community reflects a conservative political perspective. It emphasizes an anti-Obama viewpoint with an assortment of negatives. Putting aside our politics, it is easy for an investor to confuse political philosophy with investment potential. Many of us were also skeptical about Bill Clinton and enthusiastic about George Bush. The investment results are not so obvious. My basic idea is that we should be politically agnostic — eager to make strong investment returns no matter which party is in power. The strength of the American economy — the people, the innovation, and the determination — is more relevant than a specific political regime. Take a look at history to verify.
False Conspiracies. Investors may believe that everything is manipulated. It is natural. We want to have a logical explanation for every market move. Financial journalists oblige us with their best daily guess. Most of this is speculation. In particular, take note of Eddy Elfenbein’s article on the “Plunge Protection Team.” This is entire consistent with my own piece, as well as a nice sidebar in Bailout Nation by Barry Ritholtz.
This is not an easy one. Most of what we all read is designed to reinforce what we already believe. That is how the author gets to be popular.
Seek out — actively and energetically — alternative viewpoints.
My web analysis team tells me that hardly anyone clicks through to links in these articles. My estimate is that it takes an extra hour per post to document sources appropriately.
I also have a scientific study demonstrating that those who click through to do research have twice the investment returns of those who do not. (OK — I made that up).
Anyway, I provide backup for a reason. I know it is a vestige from my professorial days when I was trying to help students by showing the key information, but perhaps you will also find it helpful.
Originally published at A Dash of Insight and reproduced here with the author’s permission.