Q: I’m nervous about the market. Should I sell my stocks?
A: Investors have struggled with this question from time immemorial. It turns out that most of us know the right answer, but human nature endeavors to place a stumbling block in our path.
Successful investors stick to a long-term plan, and learn to overcome the innate temptation to bail out when the market sputters, or to jump in just as it pops. However, this degree of discipline is so challenging in practice and so contrary to intuition that most individuals are unable to achieve it.
Dalbar Inc. of Boston has been measuring and analyzing the effects of investor decisions to buy, sell and switch into and out of mutual funds since 1994.
The results of its latest quantitative analysis of investor behavior confirms the difficulty investors’ experience in sticking with a long-term investment philosophy. For the 20-year period through 2009, the average investor in equity mutual funds earned a return of 3.2 percent per year.
Meanwhile, a straight buy-and-hold stock investor in the S&P 500 averaged 8.2 percent per year, a difference of 5 percent every year for 20 years. To put this deficit in perspective, consider a $10,000 original investment made in 1990. Assuming annual compounding and reinvestment of returns, the individual investor would have seen his nest egg grow to $18,775.
Meanwhile, the hypothetical investment in the S&P would have blossomed to $48,366 by avoiding the mistake of buying high and selling low during the market swings of the previous two decades.
Fixed income investors actually posted a worse relative performance. The typical bond fund investor logged a 1 percent annual return since 1990, while the Barclay’s intermediate bond Index turned in an average 7 percent per year, a difference of 6 percent per annum.
The good news is that the differentials are diminishing over time as investor education improves, but the fact remains that impatience and cognitive dissonance negatively impact investment returns for most individuals.
Staying committed to a focused, disciplined strategy is the key to getting out of one’s own way. Setting reachable goals and then establishing an appropriate asset allocation among the various classes of investments (stocks, bonds, cash, gold, etc.) is far more important than speculating about whether BP is a buy at $33. The right proportion of asset classes and proper diversification within those classes, can help to fortify an investor against the pernicious temptation to time the market.
Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Chris Hopkins is vice president, investments, at Barnett & Co. Inc. Submit questions to his attention by writing to Business Editor John Vass Jr., Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by e-mailing him at jvass@timesfreepress.com.