DIY Investors Are Sabotaging Their Portfolios

3 tips on How to get out of your own way and embrace passive investing

Photo by Joseph Frank on Unsplash

Do It Yourself (DIY) investors self-sabotaging their portfolios without realizing it.

According to Morningstar’s annual “Mind The Gap’ report, investors are underperforming the funds they invest in by 1.7% per year over the past decade.

• The average fund in the study returned 11% per year

• Meanwhile, the average investor returned 9.3% per year

• That is a 1.7% annual difference

1.7% may not sound like a lot, but let me be clear this is a potentially life-changing amount of money.

Let’s say you invested $100,000 when you were 25, never invested another dime, and pulled the money out at age 65.

• The portfolio returning 11% per year would end with $6,500,086

• The portfolio returning 9.3% per year would end with $3,505,956

• That is a difference of $2,994,130

Giving away 1.7% per year meant you ended up wit half as much money as you should have.

(Note: Both 11% and 9.3% are probably higher returns than you should expect in the future.)

Why investors lag fund performance

All humans suffer from cognitive biases that lead to irrational investment decisions.

There are three psychological traits in particular that are hurting DIY investors.

1. Fear

2. Greed

3. Overconfidence

Fear and greed are two halves of the same coin.

In their report, Morningstar found that in periods after funds performed exceptionally well, investors poured a lot of additional money into that fund. Following periods of underperformance, investors began selling their investments in that fund.

Translation: Investors were buying high and selling low. You don’t need to be Warren Buffet to realize that isn’t a recipe for investing success.

Investors also suffer from another bias; overconfidence.

This overconfidence can lead to market timing decisions that seem like good ideas at the time, but most often lead to underperformance. These are the people who say things like, “I don’t want to invest right now while we are at the top of the market.”

But did you know that when the stock market is at an all-time high, it’s more likely to continue creating new all-time highs than crash?

This chart measures how many days the S&P 500 closed at a record high in a year.

Data source: S&P Global, chart created by the author.

Here are a few other facts about investing when the market is at an all-time high.

• 6 out of 10 years since 1958 have seen multiple records in the S&P 500.

• Including years with zero new records, the market closed with a record-high 18 times per year on average.

• Excluding the years with zero new records, the market closed with a record high, an average of 29 new all-time highs per year.

So, if you think you’ve called the “market top” and pull your money out—the most likely scenario is that you lose money.

3 Tips to help DIY investors get out of their own way