Why Do Investors Under Perform The Equity Markets?

When dealing with investors I have heard a number of questions.  The most frequently asked is; what will the market do next?  Every one of them believes someone knows what will happen next. Investors are in constant search of the ‘expert’ that will give them the answers and ‘beat’ the market. The media makes sure you continue to believe that these ‘experts’ exist.

Investors (Photo credit: LendingMemo)

Unfortunately, there are no answers to the question; what will happen next? While investors are searching for the right answer they lose money unnecessarily.

This is evidenced by the Dalbar research study which looks at individual investor performance over a 20 year period. The latest study revealed that the 20 years ending December 31, 2012 average annual performance S&P500 earned 8.21% while the individual investor earned 4.25%.

Why the difference? It can partially be explained by the investors search for the best entry and exit point. This is called market timing and it doesn’t work.

These investors are looking for stock market returns with Treasury bill risk and what they end up with is Treasury bill return with stock market risk.

The invisible hand of the market sets prices more efficiently than any other process known to man.  Is it perfect?  Indeed, No.  There is no perfect price; only what a willing buyer and seller negotiate.  The market instantly incorporates the collective mind of every market participant.  Free markets work.  Unfortunately, most investors never tap their real power.

Many prefer the apparent stability of real estate investing. They conclude that there is much less or no volatility in real estate investing. What these investors don’t realize is that equities remain the greatest wealth creation tool on the planet. That’s right equities are the greatest wealth creation tool on the planet IF they are used properly.

What investors also don’t realize is that one of the advantages of equities is actually why investors prefer asset classes like real estate. That advantage is liquidity. Equity owners have access to their investments nearly immediately. That means they can look up the price at any moment that the markets are open.

This opens these investors up to sometimes large short term down swings. These swings result in some emotional decisions, like panicking and selling during a downturn. It can also result in buying at a high when there is frenzied buying. Real estate investors do not have this ‘luxury’. Basically real estate investors believe….. If I don’t see it, it can’t hurt me.

Stop trying to beat the market and let the market forces work for you. Treat your portfolio like you would a real estate investment. Be patient. This will be accomplished by

  • Own equities and high quality fixed income.
  • Globally diversify.
  • Rebalance.

These 3 simple rules will lead to a successful investing experience.

In most if not all cases this will require the help of an investor coach/fiduciary adviser. Your coach will help build the right portfolio for you and most importantly keep you disciplined.

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Location…location….location is the real estate path to success. During discussions with many investors the subject of real estate comes up repeatedly. Many believe that real estate carries no risk or very little risk.

Real Estate
Real Estate (Photo credit: allan.hane)

During a recent conversation with a successful business person we discussed equities in a portfolio. This investor said he would not invest in stocks because he did not want to lose 30 or 40 or 50% as seen during the 2008-9 crash. He held his wealth in land, as in raw land.

This conversation represents many investors, although most deal with commercial real estate with a steady cash flow. What these investors do not realize is that the value of their real estate did go down during this recent crisis. I believe the reason more people make money in real estate than in the equity markets is that they cannot see the value of their holdings on a daily or hourly or even by the minute.

The only way to compare the two investment classes is to have an independent professional appraisal done at least monthly. Naturally this is unreasonable and a very expensive solution. There have been numerous studies on this subject and the common conclusion is that real estate follows the equity markets whether up or down.

On the residential real estate side, a house in my neighborhood was put up for sale in 2008. It remains unsold. It is a very nice home on a golf course. Is it because there are no buyers? Or is the seller unwilling to lower their price? Or both?

Even for those with commercial holdings with a steady cash flow. If the equity markets were to go down and stay down this cash flow would dry up. Many of the expenses would not go away if the cash flow would end.

The question needs to be asked, why do investors focus on the long term when dealing with real estate and then focus on the short term when dealing with the equity markets?

Could their emotions be guiding them? No one asked how much did you lose in your real estate holdings during the 2008 crisis. However many panicked when the equity markets were down 38% and sold at the low. The transparency of the equity markets makes your investments visible for all to view. Your ego will be bruised when the equity markets are in a ‘bear’ market.

Investors need to understand that the equity markets are actually the greatest wealth creating tool on the planet.

Like any tool, equities need to be managed correctly.

Warren Buffet has been a successful investor for a very long time and he has two basic rules: “Don’t listen to forecasts, and don’t try to time the market”. Your focus when investing in the equity markets must be long term.

Please do not misunderstand, I do not think real estate is a bad asset class. It is an asset class like all others, with positive and negative components. Real estate can be a valuable part of your overall portfolio.  It should only be part of your diversified portfolio.

With the help of an investor coach you can build a prudent portfolio that is best suited for you and your unique situation. It is not about, what is the best stock today?  Or should I be in or out of the equity markets?

It is about developing YOUR prudent portfolio and remaining disciplined.

Because of the attention the media pays to the equity markets you will need help in controlling your emotions. This is true in both down and up markets. Many will try to concentrate their portfolio in the ‘hot’ asset class. Only to be disappointed and discouraged when this ‘hot’ asset class suffers losses.

You will need an investor coach to build the right portfolio and keep you disciplined.

To succeed long term in the equity markets you need to follow three simple rules:

  • Own equities
  • Globally diversify
  • Rebalance
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