Don’t Get Emotional: The Reason for a Sluggish Average Investor Return

Investor Behavior and Pressure on Financial Advisors Leads to Underperformance

It’s not easy being green, and no one knows that better than the average or amateur investor. Over the past couple decades, the average investor return has paled in comparison to the S&P, and mutual fund investors are not making the returns that they initially expected. What’s the deal?

The Wall Street machine is interested in creating products for profit and not creating profit for the end user. Once you understand the rules of mutual fund investment, the better equipped you’ll be to use them to your advantage.

The disappointment in an average investor return is often directly caused by his or her inability to handle emotions. Investor behavior is often illogical and filled with emotion. The insecurities that people feel are often exposed in the way they trade. This does not lead to wise long-term mutual fund investment decisions. In fact, overconfidence promotes the emotional imbalance seen in many amateur stock pickers.

Overconfidence: How Mutual Fund Investment Went from Boom to Bust

From 1982 to 2000, unless you purchased a short bias hedge fund, the average investor return produced significant money by simply staying in a portfolio that consists of 60% equities and 40% bonds. Unfortunately, this gave amateur investors a false confidence in their ability to select the right companies. Since 2000, the decision whether to buy or sell in the mutual fund investment market has been an emotional rollercoaster for the average investor, leading to misguided investor behavior.

For 16 years, I worked in the trenches of Wall Street marketing mutual funds, hedge funds, closed-end funds and private equity investments to stockbrokers and registered investment advisors.

The pressure to sell was piercing. On multiple occasions, my comrades and I were pushed to solicit sub-par mutual funds to financial advisors and their clients. Management was primarily concerned about the fees we would collect. As a CFA candidate, I was compelled to disassociate from this offering. This caused upper management to look at me as a malcontent. Consequently, I left to join a firm whose value system was more aligned with mine.

To understand how the average investor can compete with institutional investors, it is important to understand why the average investor has failed. We often hear about retail investors and institutional investors in the global stock market. Often, retail investors have a nascent knowledge of the stock market. They depend on the news in the market or tips from their financial advisor who most likely has an investment acumen close to that of their client.

Many average investors are seen copying the moves of their larger counterparts, which can be disastrous for them. By the time the move is made, it is too late, and they wind up on the wrong side of the trade.

It is important to note that equity securities simply fluctuate to a greater extent than those of investment-grade bonds (most of the time). In my professional opinion, this does not make equities inherently riskier than bonds. Although this is a discussion for another paper, I believe it is important to point out that standard deviation (volatility) does not fit the definition of risk.

Mutual Funds vs S&P 500: How the Average Investor Return Has Changed

The 20-year annualized S&P return is just over 10%. However, returns for equity mutual fund investors have trailed behind. During a tumultuous 2018, the average investor underperformed the S&P 500 by 113 basis points during a bad market month and 146 basis points in one of the market’s strongest months. .

Based on annualized returns from 2005 to 2015, the investor who placed $10,000 in the equity mutual fund would receive $25,000 at the end of the 20-year period, and the investor who purchased a security that tracked an S&P 500 index fund would have seen their $10,000 investment grow to $65,000. That is a considerable difference for most retail investors.

Financial Advisors Feel the Heat in Selling Mutual Fund Investments

There is a lie that permeates through Wall Street that hinders the average investor return and keeps investors’ portfolios from accumulating gains similar to that of the S&P 500. The lie is that the average investor is made to believe they are emotionally equipped to manage money against some of the best investors in the world. There is little doubt that having a good financial advisor with mutual fund investment management skills can help bridge the gap in performance, as advisors are placed in a position that does benefit the client.

The pressures faced by many advisors to gather new prospects, increase assets under management and keep their existing client-base informed on their progress makes being a financial advisor one of the hardest professions in the world. Most financial advisors are only paid to sell certain products or gather assets. If an advisor does not recommend the products they are told to sell by their manager, they won’t be putting food on the table, regardless of the effect on the average investor return.

Financial advisors need to sell insurance and annuities that pay substantial commissions early in their careers. They should not be blamed for working in a system that wants most of them to fail. Once they leave, other financial advisors pick up their accounts and the cycle continues. This pressure on financial advisors directly affects investor behavior, and the investor suffers.

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Basic Investment Principles 101 – From Asset Allocations to Zero Coupon Bonds and Advanced Investing Topics: Unicorns and Pre-Unicorn Scalable Private Company Propositions. This is an updated version of an article published on May 14, 2014.]