3 Reasons Why the Average Person Actually Stinks at Investing

Over the long run, the S&P 500 has delivered annualized returns of 9% to 10%, depending on the exact multi-decade time frame you're looking at. But the typical investor doesn't do nearly as well as they would by simply buying an S&P 500 index fund and matching the stock market's performance.

According to the 2023 Dalbar Quantitative Analysis of Investor Behavior (QAIB) study, the S&P 500 produced a 9.65% annualized total return in the 30-year period through the end of 2022. However, the average equity fund investor only managed a 6.81% return over the same period.

To put this in perspective, a $10,000 investment in the S&P 500 would have grown to $158,584 over those 30 years. However, the average investor's returns would have grown to less than half of that amount.

Why does the average investor do so poorly?

Of course, every investor is different, and there can be some unique situations that explain poor performance. For example, if you had a disproportionate amount of your money in bank stocks before the 2008–2009 financial crisis, it could certainly weigh on your long-term performance. But for the most part, the average investor underperforms the overall stock market for three reasons.

• Emotional investing: Investing based on emotion can lead you to make portfolio moves at inopportune times. When we see all of our friends making money in a bull market, we get the urge to put as much money as we can in the market. Conversely, when the market is crashing and your portfolio is way down, it is human nature to want to sell and cash out before things get any worse. It is common knowledge that the goal of investing is to buy low and sell high, but our emotions encourage us to do the exact opposite.
• Overtrading: This is similar to the above reason, but one of the biggest reasons cited in the Dalbar study to explain investors' underperformance is moving in and out of investments way too frequently and trying to time the market. If you sell every time a stock or mutual fund goes up a little and move your money into something else, you're missing the point of long-term investing.
• High fees: A 1% annual investment management fee might not sound like a lot, but you might be surprised at the impact it can have over the long run. As a simplified example, a $10,000 investment in an S&P 500 index fund would be worth around $152,000 after 30 years, based on the index's historical rate of return. However, if you paid a 1% management fee every year, the long-term return would drop to about $115,600. In other words, that "little" 1% fee would have cost you more than $36,000.

How to do better than the average investor

With those reasons in mind, there are some steps you can take to set yourself up for investing success.

Invest consistently

One of the best ways to remove emotion from the returns equation is to invest regularly, no matter what the market is doing. For example, if you plan to invest about $5,000 per year, maybe invest $100 per week in your brokerage account no matter what, even if you have the money in a lump sum. This concept is known as dollar-cost averaging, and by using equal dollar amounts at set intervals, it will naturally result in you buying more shares when prices are low and fewer when prices are high.

Buy and hold for the long run

Trying to time the market is usually a losing battle, and as mentioned, moving in and out of investments too frequently is one of the biggest reasons why the typical investor underperforms the market. So, one of the easiest ways to set yourself up for success is to keep trading activity to a minimum.

To be sure, there are some good reasons to sell stocks, mutual funds, and ETFs. For example, if something fundamentally changes with a stock you own, it's okay to sell and move on. But the goal should be to stay invested for the long haul.

Use index funds

The average actively managed mutual fund or ETF not only underperforms the market, but comes with rather high investment expenses. It isn't uncommon for a mutual fund to have an expense ratio of 1% or more, which means that for every $10,000 you have invested, $100 is going toward paying fees every year. Meanwhile, a simple S&P 500 index fund can cost as little as 0.03% in annual investment fees and has historically delivered a 9% to 10% annualized total return over long periods.

To be sure, if you have the time, knowledge, and discipline to invest in individual stocks, go for it. But if you don't, putting your portfolio on autopilot can set you up for better long-term returns than you might think.

The bottom line

The key takeaway is that most investors underperform the market because they let their emotions get the best of them, they try to incorporate too much "market timing" into their investment strategy, they pay too much in fees, or a combination of the three. By understanding these concepts and taking steps to avoid making these mistakes, you can set yourself up to handily outperform the average investor.