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dzonefx
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Date of Entry : 2013-01-29
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Sven Tells You How

on Thu Dec 08, 2016 5:40 pm

  • Average investors don’t even make 50% of the market’s return.
  • The stock market looks simple in hindsight, but behavioral issues stop us from doing the right thing. We’ll see how by looking at an example with Wal-Mart.
  • To make market returns you have to do nothing. But to make above market returns, you have to do what others aren’t willing to do.

  
Introduction

According to Dalbar, average investors don’t do as well as the general stock market. In fact, they don’t come even close.

No matter where we look, at three-year periods or thirty, the average investor’s returns are consistently below market returns.


Average investor returns.

Over the last 20 years, the average investor investing in equity funds managed to annualize 4.67% while the S&P 500 returned 8.19% per year. In 2015, while the S&P 500 returned 1.38%, the average investor suffered a loss of -2.28%.

The causes of the above underperformance are behavioral. The first behavioral mistake that investors make is that they interfere with their portfolio. Buffett always reminds us that the best investment for the non-professional is a cheap S&P 500 fund on a buy and hold method. As the above figure shows, it has outperformed bonds and funds in the past and will probably continue to do so in the future.

So why then do investors take actions that lower their returns instead of sticking to the S&P 500? Well, investors don’t stick to their investments for various reasons, they try to time the market, are afraid of losing more when the market turns south, don’t understand the concept of diversification, behave like a herd and go after the hot sector when it’s too late, and are willing to pay whatever price when the stock market seems to just go up. This results in the average retention rate for a fund being only 4.1 years. 4.1 years is a much shorter period than the 10 years usually promoted by Buffett for healthy stock market returns.

However, this faulty way in which investors usually behave creates amazing investing opportunities. In the next example, we’ll elaborate on whether you’re ready to seize those opportunities.

Wal-Mart (NYSE: WMT) is often used as an example of what long term investing can do.

WMT’s stock price on January 2, 1973 was $0.04. Yes, four US cents (accounting for stock splits). The stock price at the time of writing is $70.67, which would mean that an investor who had invested $1,000 in WMT in 1973 would now have about $1,766,750 without dividends. If the same investor would have reinvested the dividends, the total return would be around $3 million. The current yearly dividend would be around $84,000, or 84 times his initial investment. That’s not bad for a $1,000 investment.


WMT stock performance

This is a beautiful story of what you can get from the stock market. You’re probably thinking now about the lucky investors that were there in 1973 who bought in and solved their financial problems, thinking how you would have done the same if you would have been there. Am I right?

But, and there is always a but with stocks, let’s take a look at figure 4 showing WMT’s stock performance from January 1973 (where we bought in in our example above) to August 1977.


Wal-Mart Stores Inc. from August 1973 to August 1977.

The price when we were supposed to make this great investment, January 1973, was $33 a share (here the real price is shown, on the previous chart I accounted for all the stock splits in order to make it easy to compare today’s price with historical prices). As you can see in figure 3, at the end of 1974 the price of the stock dropped to $8.75. So our great investment of $1,000 would have only been worth $265 in December 1974, a 75% loss. That isn’t really something to brag about at parties to show off how great of an investor you are.

In 1973, the average investor might have bought WMT in 1973, but very few investors would have held on to the stock through 1974 and 1975, and even fewer investors would have bought more.


Conclusion

The average investor who just wants to get market returns has to be smart and do the most difficult thing in investing, nothing, apart from looking for low fees. An example of low fees are Vanguard’s low cost mutual funds with a cost around 0.18% per year.

The investor whose intention is to beat the market has to dare to invest when other people are running away like crazy, changing funds due to bad performance, or selling emerging markets just because somebody says they are risker today than they were yesterday.

Going back to WMT, its price in November 2015 fell to $56. It’s funny how many investors like the stock more now than when in was at $56. Perhaps this behavior is inherent to human nature and will never change, but try not to let it interfere too much with your investing.

source: investiv
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