
Investing is usually known as one of the best methods to stretch your dollar especially when inflation is constantly eroding your hard-earned money. Stories like how Mr. Warren Buffett became one of the wealthiest in the world through his wise investments further made people believe that investing is a sure way to get rich.
Sadly, to tell the truth, most investors never get close to beating the market. According to a research report by the BlackRock Dalbar, the average investor only managed to secure a 2.5% annualized return from the period 1994 to 2013. On the other hand, the “Stocks” category being represented by the S&P 500 Index, scored an impressive 9.2% annualized return for the same period. A difference of 6.7 percentage points coupled with the compounding effect will mean drastic differences for the same initial capital!
Source: Blackrock Dalbar
If we were to delve into the common reasons why a typical investor underperforms in the market, it would be the following:
- Lack of diversification
- Frequent trading in and out of the market
- Buying/Selling based on market news or stock tips
- Lack of planning
- Working with an advisor concerned about his/her commission rather than your profits
Out of the points listed above, investing without a plan is the most critical mistake of all. This is because an investor without a plan is like a driver without a map; investors tend to succumb to their own emotions by selling out of irrational fear, or holding onto a losing trade far too long etc.
A quote by Benjamin Franklin brings across this point particularly well as he said “If you fail to plan, you are planning to fail!”.
With all said, what can a retail investor actually do to improve his/her investing returns.
One Step ahead of the rest
Like what we have mentioned just now, most investors are unable to achieve satisfactory returns, let alone beat the market. Nonetheless, you do not have to feel dismayed either. A report from Standard & Poor’s has shown that 74% of actively managed U.S. equity funds underperformed the market over the past 5 years preceding 2012.
So how can you actually do better than all the smart professionals as well as the rest of your peers? Simple −buy the market itself! Buying the market via an index fund entails you several benefits listed below:
- Wide diversification as you own smaller bits of the stocks depicted in the market index
- Low Expense ratios as compared to those actively managed by fund managers
- No/minimal monitoring required if your holding period is long term
- Lastly, index funds put you in good company. Index funds are favored by Nobel Prize winning economists, Warren Buffett, John Bogle, Charles Schwab, almost all academics and many more.
Conclusion
We’ve heard of a saying, “when you can’t beat them, join them!”. Thus, we strongly believe that we should adopt the same mentality when it comes to investing too. It makes no sense for an investor to pour hours into researching the companies and then underperform one who had just put his/her money into a passive fund and have his/her money grow at a better rate.
Image from Changemakers.com. Used with appreciation.
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