Investor behavior matters a lot. In fact, it probably matters more than skill. To understand why this is true, first you need to understand one fundamental concept: Investment returns and investor returns are almost always different.
An investment return is what you get if you invest your money at the start of a period and then don’t touch it. You don’t buy or sell. You just buy and hold. But real people in the real world don’t invest that way.
Real people are always chasing performance and investing by looking in the rear-view mirror. The result of this never-ending hunt for the best investment causes us real trouble.
The result is well documented: The average investor almost always does worse than the average investment. The difference in returns comes from making classic behavioral mistakes over and over again.
Here’s a recent example: According to Morningstar, the Dreyfus Greater China Fund had an annualized return of 24.3 percent over five years through Dec. 31, 2009. But the average investor in that fund had a return of only 14.3 percent during the same period. That’s a 10 percentage point difference.
Think about that for a minute: A 10 percentage point difference per year over five years. How in the world can that be true? Well, it’s just one example of what I call the Behavior Gap, and in future posts we will explore how and why this happens.
For now, the lesson is that investment success isn’t about skill. It’s about behavior.
This sketch and post originally appeared at The New York Times on Febuary 1, 2010.
Use of digital images are subject to the terms of this License Agreement.