We’re All Doomed: The Hopeless State of the Retail Investor

Street café in Augsberg

This is going to be a discouraging article. I don’t normally pay attention to negativity when it comes to investing. There’s always some Chicken Little out there peddling bad news. Reports that “the sky is falling” sell well and travel far. People lap it up. But the naysayers ignore one important truth; the stock market tends to go up over time. Up! Sure, there’s short-term volatility, but if you ignore the fundamental reality that the markets tend to rise over time, you’ll lose out.

We’re not doomed because the sky is falling. When it comes to investing, we’re doomed because of our own human nature. It’s hopeless. We’re all whimpering puddles of emotion. We sell when we should be buying. We buy when we should be selling. Then we blame the world when things don't go our way.

The great spiral of doom

We stay out of the market and sit on piles of cash due to fear. Then when we’re satisfied that stocks have risen well, we pile on at the top of the market. We’re greedy and don’t want to miss out. We decide what to buy based on little more than our own hubris and short term attention span. When prices fall, we ride the investment downward because we know it has to be worth what we paid for it, regardless of what the market is saying. Finally, at our point of lowest despair, we sell low because we can’t take it anymore.

Then we stay out of the market and sit on (smaller) piles of cash due to fear…

Tales from the Lynch mob

There is a shocking tale circulating about Fidelity’s Magellan Fund under the leadership of Peter Lynch in the 1980s. The story claims that even though the fund saw astounding average returns of 29 percent while Lynch was at the helm, Fidelity found that average investors in the fund actually lost money over that period. While it's tempting to dine out on this indictment of poor investor timing, it’s likely an urban myth. [1]

Still, the reality behind the story does support the sobering conclusion that we’re all in deep trouble. According to Nathan Hale over at CBS MoneyWatch, the Magellan fund was not open to the public until 1981 and over the next nine years returned a yearly average 21.8 percent [2]. That’s still impressive compared to the S&P 500’s 16.2 percent return, but Hale found that average investors in the fund earned just 13.4 percent annually over that same period.

Remember, this was one of the most successful runs of an actively managed fund in the history of mutual funds. Average investors in the fund seeing only 13.4 percent over the same stretch the fund was returning 21.8 percent is staggering. How can this be? Hale suggests it is due to poor timing. Investors were lightly invested in the early days when results were stellar and heavily invested later on, after returns weakened.

Buy high, sell low. Repeat.

This mirrors the experience of fund managers who regularly see investors pour into funds in huge numbers after a good run, only to sell out at the first correction. We pile on after an investment has already done well, and then bail after the first downturn. Buy high, sell low. Repeat.

We’re all doomed.

Don't be doomed

What to do?

  • First, accept that you’re driven by fear, greed, and ego
  • Don’t rely on your own flawed intuition
  • Don’t try to time the market; you’re not that smart
  • Have a plan and stick to it
  • Rebalance your portfolio regularly
  • Resist short-term thinking; take the long view

Jon Dearden

[1] Young, Duff (1996, July 27) Magellan Myth. The Globe and Mail. Retrieved from http://www.bylo.org/magellan.html

[2] Hale, Nathan (2010, July 26) Lessons From a Great Fund Manager’s Record. Retrieved from http://www.cbsnews.com/news/lessons-from-a-great-fund-managers-record/

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