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Why Do-It-Yourself Investors Underperform

The results of research performed by Dalbar Inc., a company which studies investor behavior and analyzes investor market returns, show that the average investor consistently earns below-average long-term investment returns.  This is amazingly consistent no matter what time period is measured.

Their 2016 study looked at the twenty-year period ended December 31, 2015.  During this period, the S&P 500 Index averaged 8.19% a year – a pretty attractive historical return.  The average multi-asset individual investor earned a market return of only 2.11%.


Admittedly, this data is outdated, spanning the 20-year period from 1996 to 2015.  However, 20 years is long enough to identify a strong trend.  The data is also consistent with earlier Dalbar studies.  While asset class returns may have modestly changed during the past five years, I highly doubt that the average individual investor has evolved to the point that his or her returns wouldn’t still be sitting somewhere towards the bottom end of this chart.

I saw similar charts early on in my own investing career and instead of getting discouraged, I decided to investigate why the average retail investor performs so poorly.  It didn’t take long to realize that there are two primary issues that we all have to overcome – fear and greed.                                 

Fear and Greed

Humans are a flawed species. We’re emotional creatures.  Often, in real life, that’s a good thing.  Joy and love, heartbreak and loss, hope and longing — these are all sensations that make life worth living.  However, when it comes the stock market, emotion is best left at the door.  It leads to undisciplined, irrational decisions, and often these emotions lead to losses.

Everyone knows it’s best to buy low and sell high.  This is an easy enough principle to understand.  However, it’s not easy to enact.

Most people love price reductions when they’re available at the grocery store, in the shopping mall, or on an e-commerce site.  However, people tend to be afraid of discounts in the stock market. 

On the contrary, many retail investors are prone to the herd mentality, where there is perceived safety.  They’re willing to chase momentum, allowing the fear of missing out to overwhelm their good sense.  Far too often, the average investor has shown a willingness to sell at bottoms and buy at tops, which is why their performance is so low relative to the performance of individual asset classes.


Why the Underperformance?  Emotions! 

We humans are emotional creatures.  Research shows that the main reasons for the dismal performance are related to emotional and behavioral factors. Turns out, the majority of us are terrible investors when investing our own money due to the way our brain is wired.  We just simply aren’t programmed to be rational, disciplined investors.  It’s not our fault.  It’s baked into our DNA!  Humans suffer from a myriad of behavioral biases which stem from emotions that impair our decision-making processes.  As a result, we tend to make irrational decisions at the worst possible times, which in turn lead to lackluster long-term investor performance.  This flaw in our make-up impacts us continuously.  Although its less obvious during roaring bull markets, it punishes us mercilessly during bear market downturns when the ramifications of our failure to adhere to a sound plan become clearer and painfully acute.   


Emotional Biases 

If you are going to manage your own investments, you will need to master your emotions and behavior.  This is not easy.  It is extremely difficult to emotionally detach ourselves from our money.  Investors need to recognize the biases they are most prone to.  Below is an overview of a few of the most powerful “money-losing” biases that control our behavior, even in those circumstances when we are fully aware: 


Buying High

Study after study shows that when the stock market goes up, investors put more money in it.  And when it goes down, they pull money out.  This is akin to running to the mall every time the price of something goes up and then returning the merchandise when it is on sale – but you are returning it to a store that will only give you the sale price back.  This irrational behavior causes investor market returns to be substantially less than historical stock market returns. 

What would cause investors to exhibit such poor judgment?  After all, at a 7% return, your money will double every ten years (see"Rule of 72").Rather than chasing performance, you could simply have bought a single index fund, and earned significantly higher returns. 



The problem is that the human reaction to both good news or bad news is almost always to overreact.  These emotional triggers cause illogical investment decisions.  The tendency to overreact can become even greater during times of personal uncertainty; near retirement, for example, or when the economy is bad.  There is an entire field of study which researches this tendency to make illogical financial decisions.  It is called behavioral finance.  The study of behavioral finance documents and labels our money-losing mind tricks with terms like "recency bias", “availability bias” and “herd mentality”.  Human beings tend to…   

·       Exhibit a recency bias, where we overweight what happened recently and extrapolate it into the future. 

·       Show an availability bias, making us more willing to invest into stocks we can readily recall. 

·       Perceive less risk in something we have familiarity with, thus helping to explain why so many are so comfortable keeping concentrated positions in their employer. 

·       Pursue gambles that have significant upside potential, despite their improbable outcome — explaining why we continue to buy lottery tickets with a highly negative expected value. 

·       Exhibit a significant aversion to losses.  Loss aversion refers to people's tendency to prefer avoiding losses to acquiring equivalent gains: it is better to not lose $5 than to find $5.  The utility of a monetary payoff depends on what was previously experienced or was expected to happen.  Some studies have suggested that losses are twice as powerful, psychologically, as gains. 

·       Move with the herd, showing a strong bias to do what everyone else is doing, and avoid the risk that comes with being singled out — especially if there’s a bad outcome and someone needs to be blamed. 

·       Overconfidence.  Investors repeatedly overestimate their ability to predict market events.  This leads to higher frequency of trading, which typically results in lower returns. 

·       Chasing Performance.  The average investor repeatedly performs the cardinal sin of investing, which is “buying high and selling low”.  Studies show that individual investors tend to wait to invest until they see strong market returns.  By the time their money is invested, they may have missed the majority of the market increase.  On the other hand, investors tend to panic after a significant decline and usually sell out near the bottom.  Waiting too long to invest and selling on fear will inevitably hurt a portfolio’s return.   

These are but a very few of our biases that negatively impact our decision-making.  If you want to blow your mind, take a look here at the many others that make up the full and depressing list:  (P.S.  Is it any surprise that our politics are so broken when you see the complete list of cognitive biases that drive our thinking?) 

A picture (or bar chart) that’s worth a thousand words

What is a wise investor to do? 

As the research shows, most individual investors have a difficult time ignoring their emotions when making investment decisions over their own money. But if you’re one of the rare individuals that can consistently do all of the following things, you may not need professional help.  Ask yourself if you can… 

·       invest the time and energy to create, implement and stick with a thoughtfully designed asset allocation plan (known as “investment policy” in industry jargon).   

·       design your investment policy to produce an “expected return” that is consistent with your long-term goals and ability to accept risk.  Risk and volatility are inherent in investing.  There is no “free lunch”.  Risk and return are always inversely related.  Risk doesn’t always manifest itself immediately, but tends to overwhelm after long periods of complacency. 

·       select low-cost, tax-efficient index funds or ETFs to build your portfolio consistent with the asset allocation plan defined in your investment policy. 

·       rebalance your investment portfolio periodically to maintain the desired allocation, all the while being aware of the tax consequences of your actions. 

·       harvest losses periodically to build a war chest of tax loss carryforwards that can be used to mitigate the inevitable tax consequences that will result if you’re successful. 

·       ensure that each of your investment assets is located in the ideal type of account to minimize future taxes.  This is known as “asset location” (as opposed to “asset allocation”).  For example:  

o   Real estate investment trusts or REITs should always be held in tax-deferred retirement accounts since they pay high “unqualified” dividends that are subject to high ordinary income tax rates.  

o   Precious metals should ideally be located in tax-deferred retirement accounts since their long-terms gains are taxed as “collectibles” at a 28% rate rather than the regular 15% capital gains tax rate. 

o   High dividend paying value stocks and funds should be held in taxable investment accounts to take maximum advantage of the qualified dividend tax rate of 0%, 15% or 20% depending on your taxable income. 

o   Assets with high long-term growth expectations should be located in Roth IRAs or Roth 401(k)s where their long-term growth will occur completely tax free.  

·       sit tight and do nothing in periods of extreme market turmoil or other times of great personal stress.  This is when otherwise disciplined investors make their greatest mistakes that destroy their long-term average returns. 

Don’t overestimate your ability to keep fear and greed in check when managing your own money.  Even highly-skilled professional investment managers who do this for a living tend to outsource the management of their own portfolio to another investment manager.  All humans make emotional mistakes when it comes to their own money.   

Unless you have the logic and emotion-devoid disposition of Leonard Nimoy’s “Spock”, greed will slowly and deliberately cause you to deviate from your well-designed plan.  Likewise, fear will cause you to panic during periods of stress.  This is why the average investor in America fail to produce investment returns much better than the rate of inflation over long periods of time.  The past twenty years included two market crashes and several other periods of extreme volatility.  It took many investors 15 years to recover from the tech collapse of 2000 when the NASDAQ lost 78% of its value and broad US stocks fell by more than 50%.  A similar fate befell many less disciplined investors in 2008 when financial institutions collapsed, decimating investment portfolios and causing the Great Recession of 2008.  Those were the two biggest drops since 1987 and 1929.   

Significant market corrections tend to occur every 8 to 12 years.  None of us know when the next one will come, how severe it will be, or how long it will take to recover.  We can’t control returns, but we can control the risk we take to achieve them.  Absent an infallible crystal ball, asset allocation (spreading your eggs across different baskets) is a basic strategy in any well-designed investment plan.  Notice in the chart below the unpredictability of returns for each asset class from year to year.  Last year’s winner may be next year’s dog.  Or repeat for another winning year.  Putting too many eggs in one basket almost always results in broken eggs.  

Individual asset class returns in any given year are random and unpredictable.

Owning roughly equal weights of most asset classes (periodically rebalanced) produces a higher likelihood of solid and consistent returns.  I follow a discipline of investing across 7 asset classes, which I further divided into 20 sub-asset classes.  Each asset class and sub-asset class has been carefully selected based on their previous return history and their lack of correlation to each other.  Some can be expected to zig when others happen to zag.  After all, if the asset classes all performed equally, there would be no point in diversifying.  Historically this level of extreme diversification has produced returns similar to the best performing single asset class, but with much less risk and less volatility.   

In the following chart, notice that an equally weighted 7-Asset Class Portfolio produced an average annual return that was almost as high as the best performing asset class, but with (a) much less volatility (i.e. a lower-standard deviation from the mean), (b) more shallow periodic losses and (c) fewer negative years.  Although this data covers a full 46-year period, the same pattern repeats itself over any ten-year rolling period that one might choose to analyze. 

This data provides solid evidence for a well understood phenomena:  Following a disciplined investment strategy that equally weights multiple asset classes is likely to produce consistently higher returns with less stomach-churning volatility than owning any single asset class alone.   

This demonstrates a counter-intuitive but mathematically sound anomaly.  It consistently works because returns experienced by each individual asset classes tend to be non-correlated or even negatively correlated to each of the other asset classes.  Each responds differently to uncontrollable factors such as inflation, interest rates, government policy, and the ebbs and flows of dozens of other factors including human behavior.  Including them all in the mix smooths out the returns for the portfolio as a whole as those factors unexpectedly take center stage from time to time.     

Loss avoidance is the key to making this work.  Full recovery from a market loss requires a gain equal to roughly twice the magnitude of the original loss.  For example, after a 20% loss, it takes a 40% gain to return from the new lower base to get back to the original starting point.  Minimizing the size of periodic losses through effective asset allocation and routine rebalancing minimizes the size of the subsequent gain that is needed to fully recover.  One of the many pearls of wisdom dispensed by Warren Buffett is “Rule No. 1: Never lose money. Rule No. 2: Don’t forget rule No. 1”.  In reality occasional losses are inevitable, but keeping those losses shallow is the key to long-term success. 

Investing during bull markets always seems easy.   

Just ask your next-door neighbors, friends and co-workers who may not know much about behavioral science, portfolio design, market discipline, rebalancing, tax loss harvesting, the math behind Buffett’s Rule #1, and who may have forgotten the stomach-churning lessons of 2000 and 2008!  However, they marvel at their own bull market investing prowess and wonder why you would pay someone to do what they do so easily.  That is the fallacy of focusing entirely on return, without understanding the risks one took to achieve that return.  Like a bad houseguest, those risks have a way of showing up unexpectedly and with great fanfare at very inconvenient times.     


Yes, investing always seem easy when everything you buy keeps going up.  Flaws in portfolio design, tax efficiencies, high fund expenses, and the failures to rebalance and harvest losses are easily ignored when the markets are rising.  Rising markets hide these sins.  But even in these good years, an undisciplined investor may be leaving money on the table.  The inherent costs mount through good times and bad, but are often unrecognized until the portfolio heads south.  Only then does the importance of asset allocation, rebalancing and tax loss harvesting tend to come into sharper focus.  Lack of attention to these disciplines tends to quietly punish investors even in good markets, but can be quite painful when markets turn negative as they inevitably do from time to time.   

For those Spock-like individuals who have the skills to build and consistently maintain a well-designed asset allocation plans – and who have superhuman abilities to detach oneself emotionally from their money during periods of great stress – going it alone may be for you.  But for the other 99% of the population, including many investment professionals, their challenge is to find competent and trustworthy professional help that will put their client’s interests ahead of their own. 

It’s an industry that is known for “smoke and mirrors” sales tactics and high fees charged by commissioned brokers and insurance agents, where does one find a true professional who will put your interest first?  Here’s a foolproof formula: 

·       Competence:  Make sure that your advisor is a CERTIFIED FINANCIAL PLANNERTM.  Good investment management begins with a well-designed and comprehensive financial plan.  Only CFPs have the skillset and industry-leading resources to build such a plan.  Most others offer “financial plans” that are little more than sales tools in disguise. 

·       Integrity:  Only work with someone who is a FIDUCIARY.  Stockbrokers and insurance agents are not fiduciaries.  They may call themselves “financial advisors”, “financial consultants” or “financial solutions advisors” (nobody like the titles “salesman” or “asset gatherer”).  But make no mistake, most of the people hiding behind these titles are commissioned stockbrokers and insurance agents in disguise.  The job is to keep as much of your money as they can get away with.  Their only obligation is to recommend “suitable products” – a very low bar.  You should only do business with “Registered Investment Advisors”.  Only registered investment advisors are fiduciaries.  Fiduciaries have a legal obligation to put your interests ahead of their own.  These others do not.  Ask for their Form ADV-Part 2 (their regulatory “firm brochure”) which all Registered Investment Advisors must provide. 

·       Fee-Only:  Know how your advisor is compensated.  “Fee-only” advisors reduce conflicts of interest by fully disclosing their fees and refusing to accept product sales commissions, mutual fund trails and any other forms of third-party compensation.  Fee-only advisors are more likely to recommend products like index funds and ETFs that are much less expensive since they don’t provide kickbacks to the advisor.  Be careful of the deceptive words “Fee-Based”.  That’s a clever way of saying that they take commissions, trails and other product sales compensation in addition to the fees that you pay to them directly.  Sadly, how much they’re paid and who pays them is not required to be disclosed. 

·       Track Record:  Check out the advisor and their firm at:  

o   For CFPs: 

o   For Commissioned brokers:   FINRA's BrokerCheck 

o   For Registered Investment Advisors:  SEC's Investment Adviser Public Disclosure 

·       Top questions to ask and other tools:


How does your financial advisor stack up?

 Comprehensive Money Management

·       Certified Financial Planner?  YES Ö

·      Fiduciary?  YES Ö

·       Fee-only?  YES Ö

·       Track Record?  YES Ö 

·       Financial Planning?  YES Ö

·       Design and Implementation of Investment Policy Statement?  YES Ö

·       Routine Rebalancing?  YES Ö

·       Tax Loss Harvesting?  YES Ö

·       Timely Response to Your Needs?  YES Ö

·       Attention to Detail YES Ö

·       Comprehensive set of services including tax preparation?  YES Ö

·       Market-like returns with less than market risk?  YES Ö

·       Strong track record during periods of turmoil?  YES Ö


Thanks for trusting in me and thanks for being such a great client! 




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Comprehensive Money Management Services LLC (“CMMS”) is a Registered Investment Adviser located in Coral Gables, Florida. The firm is registered with the State of Florida Office of Financial Regulation. CMMS and its representatives are in compliance with the current filing requirements imposed upon Florida-registered investment advisers and by those states in which CMMS maintains clients.

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