In fact, studies of investor behavior show that many investors do respond fearfully. Unfortunately, such reaction results in dramatic and long-term hits to their portfolio returns.
The most cited study on this topic was conducted by Dalbar, a research company that examines many factors affecting mutual fund, broker/dealer, discount brokerage, life insurance, and banking industries. DALBAR's study, entitled Quantitative Analysis of Investor Behavior (QAIB), concluded that most individual investors sell during market lows and, as a result, on average achieve returns that are lower than inflation. Specifically, the study found that:
- From 1985 to 2004 when inflation averaged 3.0%, average mutual fund investors achieved a 3.7% annualized return as compared to the S&P500 return of 11.9%.
- Investor greed leads them to invest in top performing funds at the end of bull markets while fear leads them to withdraw money toward the end of a bear market.
Today, fear is at all time highs and we’re seeing individual investors cashing out their 401ks and turning stock portfolios to cash. When you hear your friends taking such actions, it’s tempting to follow in their footsteps.
One of the main benefits of working with an advisor is access to an independent opinion in times of panic. Advisors often step in to prevent investors from acting out of fear. In addition, good advisors will construct well-diversified portfolios that reduce risk during volatile times and provide a level of equity exposure that is appropriate to the individual client’s financial situation.
Those investors who have a plan, have appropriate allocations, and who avoid fearful reaction to difficult equity markets are rewarded with the returns they deserve - average long-term equity market returns in the range of 8-10%.
