In 2018, the average investor trailed the S&P 500 by 5.04%, according to the DALBAR QAIB study (1).
S&P 500 index = -4.38%
Average investor = -9.42%
Why? Don't ask your brain, ask your intuition.
5.04%. That is simply amazing. The average investor magnified their losses by a factor of 2.15.
As the markets tumbled in December, investors began to act on their fears. They had flashbacks of 2008 in which the S&P 500 lost 37% over the year. They believed that this isn't just a market correction, but rather is the start of a larger bear market or the coming of a recession. Selling began. Investors flocked to cash to feel safe and sheltered from further losses. "I am okay with my 9.42% loss, but I cannot subject myself to anything worse."
In the final days of December, the S&P 500 provided positive returns in three out of the last four days. This included a single day return of 4.4% on December 26th. Feeling safe in cash, many investors watched the market rally from the sidelines. Instead of avoiding the drop, they missed the rally.
This is risk aversion. A common bias, easy to define, but very difficult to manage. A good example of this: You are offered a chance to flip a coin to win $10 or $0. Alternatively you are offered to take $5 guaranteed. What would you do?
Now switch the bet: You are offered a chance to flip a coin to lose $10 or lose nothing. Alternatively, you are offered to lose $5 guaranteed. Now what would you do?
This is a parallel to the risk investors assume in the financial markets. Investors would likely be better off not making their decisions based on the direction of recent volatility. When market volatility creates negative returns, investors make emotional decisions. Those emotional decisions make for poor investors.
Although the definition of average investor has room to be interpreted, this information should shock anyone, average or not. I wish I could say that people would take this information in, act on it, and take the time to reflect on the costs of their poor decision making. However, that is all in the past. It is on to the next adventure in which our emotions will excite our minds and only the few will be able to ignore themselves.
(1): https://www.dalbar.com/Portals/dalbar/Cache/News/PressReleases/QAIBPressRelease_2019.pdf