August 18, 2014 | by Justin Capetola and Drew Balis
For many investors, successfully investing in the stock market can be akin to children conquering their fear of a massive roller coaster.
Watching the ride from afar and seeing other people hold their hands up in anticipation, it all seems so fun and draws you in imagining the thrilling possibilities, but the huge drop makes it equal parts scary.
A young child on his/her first coaster might scream for the operator to stop the ride, but this is where the novice roller coaster rider and the wise investor differ. Too many people are following the path of the scared child and reacting emotionally to a brief fall in the market rather than intelligently waiting out the ride, or better yet capitalizing on an opportunity and enjoying it.
According to the chart below that aggregates data from various financial services, the track record of the average investor over the past two decades has been well below average. All but three asset classes provided better returns, and even cash turned in a stronger performance.
Let’s put this in perspective with some numbers. According to a 2013 Dalbar study that compared the performance of several asset classes over the course of two decades, the Standard & Poor’s 500 index has generated an 8.21 percent return over the past 20 years while investors in U.S. stock mutual funds barely saw half of that at 4.25 percent.
How might that impact you?
Take this example from the New York Times. An initial investment in the S&P 500 in the year 1993 would have provided an investor $48,456 on December 31, 2013 while the alternative investment in U.S. stock mutual funds would only yield $25,467, a significant difference of nearly $23,000.
For parents concerned with saving money for their kid(s) education, $23,000 would cover a year of tuition at several universities.
The core reason for this aforementioned 4 percent lag is that people are buying high and selling low rather than the proper buy low, sell high technique.
Instead of approaching stocks with a diversified, long-term vision, too many investors are chasing instant gratification and hopping on the bandwagon too late. Then, when it hits a speed bump, they jump off.
Dalbar president Louis Harvey puts it well in saying that people “move their money in and out of the market at the wrong time. They get excited or they panic, and they hurt themselves.”
Harvey emphasizes that “the most important thing, once you have a strategy, is to find a way to actually stick with it.”
Those who do remain level-headed will be rewarded according to Wharton professor Jeremy Siegel, who states that “volatility scares enough people out of the market to generate superior returns for those who stay in.”
If professional football teams could be publicly traded, it would be similar to someone buying stock in the Seattle Seahawks right now. The Seahawks might defy past odds and repeat as Super Bowl champions, but their stock is already so high that there is little space for growth and too much room for a downward trend for someone jumping in now. An individual who bought the Seahawks a few years ago would be seeing huge returns, but people who want to get in now are too late to the party.
The forward-thinking investor would seek out a buy-low opportunity with a team that has struggled recently but is showing signs of turning things around so the individual may reap large benefits once they do.
Hopefully this advice will help you to avoid some of the biggest stock market pitfalls. At Blue Bell Private Wealth Management, we recommend a long-term approach that focuses on uncovering hidden value. We always welcome visits from our clients and are happy to help you build a diversified portfolio of stocks.
The stock market is a great opportunity for investors to maximize their returns, but in order to succeed, you need to embrace the chaos and ride the roller coaster.