Looking at the University of Chicago’s CRSP total market
equity database as representative of the U.S. market for the
period 1926-2011, only the top-performing 25% of stocks
were responsible for the market gains during this timeframe.
The remaining 75% of the stocks in the total market database
collectively generated a loss of -0.7%. This example demonstrates the difficulty in selecting the individual stocks that will
perform better or even in-line with the broad equity market. It
is important to note that past performance in any security is
not indicative of future results.
Threat 5: Missing the Best Days in the Market Can Lower
Returns
Many active investors try to move much or all of their money out
of the market when they believe a bear market or down cycle
is imminent. However, this may result in missing not just down
days but some of the best (most bullish) days in the markets as
well.
This mistake can be dangerous to your wealth!
Missing even a few of the best days of the market can have a
substantial impact on a portfolio. If you had invested $100,000
in 1970, it would be worth $5,066,200 in 2011. Missing just five
of the best days would have cut your returns by almost $1.8
million to $3,294,000.8
No one knows when those “best days” will happen, yet some
people prefer to try and ride out a bear market by pulling out of
the market or just staying uninvested on the sidelines.
Results based on the CRSP 1-10 Index. CRSP data provided by the Center
for Research in Security Prices, University of Chicago.
Past performance is not indicative of future results. Indexes are unmanaged
baskets of securities in which investors cannot directly invest. The data
assume reinvestment of all dividend and capital gain distributions; they do
not include the effect of any taxes, transaction costs or fees charged by an
investment advisor or other service provider to an individual account. The
risks associated with stocks potentially include increased volatility (up and
down movement in the value of your assets) and loss of principal. Small
company stocks may be subject to a higher degree of market risk than the
securities of more established companies because they tend to be more
volatile and less liquid.
One might ask: if a small percentage of stocks could possibly
account for the market’s long-term returns, why not avoid all
the headaches and just invest in these top-performing stocks?
Since past performance is not indicative of future results, a
portfolio of even the most carefully chosen stocks could easily
wind up with none of the best-performing stocks in the market— and thus could possibly produce flat or negative returns
for many years. As the performance of active managers versus
indices shows, very few managers are accomplished stock
pickers.
Missing out on even a handful of the top-performing stocks
can leave you well short of market returns. According to an
article by William J. Bernstein in Money Magazine (05/09), the
only way you can be assured of owning all of tomorrow’s topperforming stock is to own the entire market.
Even if you’d missed just one day — the single best day —
between 1970 and 2011, you would have made a $500,000
mistake.
Threat 6: Lack of Patience and Discipline Can Be Costly
As the chart below shows, a study by the research organization
Dalbar found that from 1992 – 2011, the average investor did
substantially worse than major indices. Sometimes, we really
can be our own worst enemies. Up and down markets can be
emotional events, but as the study found, letting emotion affect
your investing can be very damaging.
In this study, the average investor returns were calculated as
the change in assets after excluding sales, redemptions and exchanges during the period. This method of calculation captures
realized and unrealized capital gains, dividends, interest, trading
costs, sales charges, fees, expenses, and any other costs.
According to this study, the average equity investor had annua l returns of just 3.5% during this time frame. Over the same
period, the S&P 500 returned an annual average of 7.8%. This
almost 55% decrease in average annual returns experienced by
the average investor is the cost of not exercising patience and
discipline, of letting emotion guide investing instead of reason.
Even in fixed income, investors made expensive mistakes. While
the Barclay’s Aggregate Bond Index returned 6.5% over this
period, the average fixed income investor had an annual return
of .94%, underperforming even inflation.
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