Do investors know what they are doing

For most of my career, I’ve been a champion of individual investors.

I cheered the rise of self-directed investors in the 1990s and hoped they would democratize markets and break Wall Street’s stranglehold. In public appearances over the past 15 years, I’ve been impressed by the number of sharp, disciplined investors I’ve met.

But since the housing bust and financial crisis, I’ve had more and more doubts.

I’ve seen people make the same mistakes two or three times: chasing “hot” individual stocks, buying horrible triple-leveraged exchange traded funds, trading frequently, etc. I’ve even wondered whether individual investors know what they’re doing at all.

Now a leading research firm has gone beyond the anecdotes, compiling a comprehensive report on investors’ performance, and it’s even worse than I thought.

Not only do most individual investors not know what they’re doing; they seem incapable of improving, according to DALBAR, a Boston-based market-research firm that measures and evaluates practices of financial-services firms.

Its 20th annual Quantitative Analysis of Investor Behavior paints such a grim picture that if it were a painting, it would look like Edvard Munch’s “The Scream.”

After citing familiar figures on how individual investors substantially underperform the market averages because of terrible market timing, the firm, which has reported these statistics for 20 years, calls out investors’ obtuseness and the miserable failure of the financial-services industry to change their dysfunctional behavior.

“After decades of analyzing investor behavior in good times and in bad times, and after enormous efforts by thousands of industry experts to educate millions of investors, imprudent action continues to be widespread,” the report asserted.

“Attempts to correct irrational investor behavior through education have proved to be futile. The belief that investors will make prudent decisions after education and disclosure has been totally discredited.”

DALBAR’s data actually go back to January 1984. They cover several bull and bear markets, the 1987 crash, the Internet boom and bust, and the financial crisis. It’s a great laboratory for studying investor behavior under wildly different circumstances.

The table at the top of this story shows the spread between returns investors could have gotten by staying invested and what they actually made.

Even in a spectacular year like 2013, investors badly trailed the market because they often piled into funds after big gains and sold after big losses. Buy high, sell low.

They earned 25.5% from their stock investments last year, while the market itself soared 32.4%. In fact, the gap actually widened in 2013 when all people had to do was sit back and count their profits.