Why You Aren’t Earning What Your Mutual Fund Says You Are
Meet the new writers! Over the next two weeks, you’ll get to meet all of our new writers. Our first writer this week is Don. Don writes about personal finance topics that include investing, saving, debt, the economy, and retirement. You can read more about Don in his bio. Welcome Don!
Like most investors, you probably look at a mutual funds past performance to gauge how the fund behaves. You may see a fund that has returned 10% per year for the past ten years and think that it would be nice to earn 10% annually. But as an investor in that fund, I doubt you would have seen a 10% return. In fact, I would bet that very few saw a 10% annual return. This is because the stated return assumes you invested in the fund for the entire ten years. You did not sell when the market dropped, or at any point during those ten years. For many investors, they sell when the market is dropping, either through fear or by trying to limit their losses.
There is a company, Dalbar, that researches investor behaviors. According to a recent report, the average investor’s holding period over the last 20 years was just over 3 years. How does this affect the average investor? In the chart below, if you had invested in the S&P 500 index for the last 20 years, you would have earned a return of 7.8%. The average investors return over the same 20 years: 2.1%.
In numbers, if 20 years ago you had invested $100,000 in the S&P 500 index, your investment would now be worth $440,873. If you are the average investor that earned 2.1% over that same period, your $100,000 is now worth $151,535.
The Reason For The Difference
Why the difference in returns? Because the average investor moves in and out of the market based on short-term events. Many people sold out in the early 2000’s after the dot-com bubble burst. They didn’t get back in until after the bull market had already kicked in. Then they sold out when the market dropped in 2008 and many have not returned to the market since, missing out on a huge rally. Other investors may be jumping around trying to find a better performing security during this time. In either case, the investors are missing out on a rising market.
Three years is a very short holding period for long-term investments such as stocks. Create a well thought out investment plan for yourself and stick to it. Without it, it’s too easy to swap one investment for another. While doing so may feel good in the short-term, in the long-term, it is going to hurt you much more.
Again, you need to stay invested in the market for the long-term. You cannot predict what the market will do tomorrow. By ignoring the short-term headlines, you are helping yourself. I know that it is not easy to ignore the drops in the market when news headlines are screaming doom and gloom and everyone at the office is repeating what they are saying. You need to do your best at tuning them all out. When you feel like giving in, pull out your investment plan and review it, knowing that if you follow it for the long-term, everything is going to work out in your favor.
Great post and great new writer! Don gave me a better understanding of what is going on and why its important to not make emotional decisions with my investments! I look forward to reading more posts!
Thanks for your comment!
Not making emotional decisions isn’t easy, trust me. But the more you learn to not make them, the easier it gets. You will always be tested, but try to always think of the long-term.
Thanks for the info. I was not aware that the performance charts were based on keeping your money in the fund for a minimum of 10 years. I will ignore any fluctuations in the market and start leaving my money where is it.
That’s a great plan….ignore what the media is saying in the heat of the moment. Keep your focus on the long-term and stay invested in the market.
Quick question for you Don. What type of return would I be looking at for 5 years or 8 years, if I couldn’t keep my money invested for 10 years.
Your return would depend on what the market did over the course of 5 or 8 years. Historically, the market has returned close to 8% per year. But, depending on which 5 or 8 year period you choose, those numbers can vary. I hope this helps!
It’s pretty interesting that all of the moving around ends up hurting more than helping. I suspect it’s a combination of investing when people should not be investing (i.e. too short a time frame) in addition to trying to time the market. Either way, I’m not surprised that the average investor’s return is lower (a little surprised that it’s about 1/4 of the S&P though…).
Nick, I was surprised at the low return as well. I thought it would have been higher, but many people stay in for a while as the market drops thinking it will come back. When it doesn’t, they bail. They lock in those losses and are then scared to get back in. By the time they do get back in, they have missed much of the rebound.
I suppose this explains why some experts advocate you buy when there is blood in the streets and sell when everything looks like it couldn’t possibly go wrong. Exactly the opposite of what most people do.
The best advice I have ever been given is to remove my emotions from my investing. Because of the way we are wired, your emotions and instincts will almost inevitably tell you to do the wrong thing when investments/money are concerned.
Excellent point Steve! You have to remove emotions from the investing equation. It’s not easy, but you have to do it.
Welcome aboard Don!