Why do Average Investors earn Below Average Market returns?

Estimated reading time: 8 minutes

Today I want to share with you a story of one of my friends, who ‘off and on’ take advice from me, but hardly follows it or follow it in bits and pieces (whatever and whenever he likes and suits him). It happens when you are not in professional engagement. Just like when people seek or try to copy advice from experts on TV shows or newspapers, and nowadays on Social Media.

(Also Read: Why Financial Planning doesn’t work in Bits and Pieces)

My friend’s example in a True sense gives you an idea on the reason behind when people say “when I invest, the market falls, and when I Redeem it goes up”. And at the end of the day feel that they are not lucky enough to build wealth in Stock markets.

(Also Read: Luck or Skill – What matters More in your Success?)

Did you ever feel like this? I am sure at some point in time you surely did. And there are many reasons to this, some of which you will relate to within this story.

The first time he (let’s call him Sumit) asked me for some advice on savings was in 2010. And since I was clear that Good Investing always has to be backed by a sound financial plan, so insisted him to share with me his complete financial details, which he reluctantly did, when I told him I will not charge anything for this ?

I found that he was serving 4 loans (Credit Card, Personal, Vehicle and Home). He was also paying premiums of 3 LIC Endowment Insurance Plans in the name of Investments. No points in guessing that with this kind of Cash flow situation, he could not participate in the Equity Bull run of 2004-2008, even though he started with his financial journey in 2002.

Actually, when he was in a Position to Start Investing, being an engineer, with no Financial understanding and even no social media around to take advice from (Pun Intended), he went to his father for Investment advice. His father with whatever experiences he has and seen people doing around, suggested that the Stock market is a Risky venture, buying home is good, and Invest safely.

So, his portfolio was showing the safety but not growth. He got what he has asked for.

But what about Loans? Why did he get into so many loans?

Because he asked his dad only for Investment advice, not for Spending advice. So, his new independent earning life led him to buy car on loan, high spending through credit cards, and funding travel on a personal loan.

He tried his hands on equity investments in 2008, looking at the then past returns, but withdrew soon with a 30% loss. This was his first time to say “when I invest market falls and when I exit it goes up”. In 2009 we saw the market recovering well.

(Also Read: What is equity? It’s much more than just stock market investment)

Now after burning his fingers, when he felt that he needed to be disciplined and organized with his money, he approached me.

I reviewed his financials, advised him to prepay the high-interest loans, with low paying deposits and by surrendering Endowment policies, and to provide him with some breather in the cash flow, to have equity mutual funds exposure for his long-term goals. This was difficult decision for him as he had to book losses in the Endowment Policies. But somehow he acted on the advice.

Now we gave his financial life a clean and sort of a fresh start, and slowly started accumulating money through Mutual funds. (Here’s all you want to know about Mutual fund basics)

But after some months the discipline went for a toss when he started finding the low and slow returns in the Investments.

Actually, he was expecting the same kind of investment returns which he saw in 2004-08, though did not participate in it. And now was expecting me to get him the same, even if the stock market was not supportive. This time I realized his idea of approaching a Financial planner, with his limited understanding on the concept.

Finally, after 3 years, of low returns, in 2013 he surrendered and decided to buy another house. I questioned him, but he justified his decision that with the family getting bigger, he needed a bigger home.

This new home was bought with another loan, while he was already serving one. He did not sell the old house to buy a new one as he could not get a “Good” Price for the same. He preferred new EMIs to SIP. Borrowings to savings. Interest paying to Interest-Earning. With additional Justification of “Tax Saving” on Home Loan interest. (Also Read: Are you ready to buy a new house?)

2014 we saw Markets recovering with new government, new expectations, but that time again Sumit was very low on equity, since all the sips were stopped and he withdrew maximum of his savings for new house down payment.

By Mid of 2016 he buckled up again and started with some savings, though small because then he was serving 2 home loans. He was still not able to sell his old house with the same old reason. Of “Good” Price.

Post demonetization on 8^th November 2016, the chances of Selling house gone bleak further.

He tried to be in discipline in savings for another 3 years, but like many, lost his cool in March 2020, after seeing the Covid fall, and withdrew again in losses.

When the sensex touched 50000 for the first time, I sent him a message to which he replied that he was unlucky, and had lost a big opportunity. What about now…Can we start again?

So, what’s the moral of the story?

These kinds of stories never come out in open as you will hear only success stories and always try to replicate the efforts and actions made by that person. Everyone wants to become Warren Buffett but as quick as possible, and only in the Bull market. In bear markets, you will find your reasons for not investing in equity. (Also Read: How prepared are you for the next stock market fall?)

You may call Sumit’s a rare case, But, believe you me, these kinds of behaviors are very common around. As an Investor you may not see such biases in you, that’s why you need a third person to guide you. Ask a Financial planner and h/she will tell how their clients behave in different market levels. (Also Read: Only 3 reasons you may need a Financial Planner)

There was research done in the US by Dalbar Inc, which says – For the twenty years ending 12/31/2015, the S&P 500 Index averaged 9.85% a year. A pretty attractive historical return. The average equity fund investor earned a market return of only 5.19%. This may look like an old data, I am sure the Investor numbers would be much worse now!

I am of the opinion that one should also learn from the failures which is more common but not visible as successes are.

This is how a normal investor behaves and reacts to different market movements. Even if you advise them the structured path to follow, with wrong expectations they tend to lose the patience and discipline.

I agree that sometimes life happens to you, but most of the time it was your reaction to life and the choices you make.

So, what do you think went wrong with this person, and how he could have made his money grow and participate in the Investment market well? From a financial planner point of view, below are my observations:

• Taking Bad loans (Credit card, Personal Loan) and that too in the early stages of financial Life– Though any loan should be avoided at this stage but bad loans are a Big NO. This is the age to build good financial habits and any bad habit could jeopardize your financial life. (My this article explains Good and Bad loans in detail)

• Serving Low yielding Insurance policies while continuing with high-interest loans– It’s a common-sense approach. I have seen people keeping Fixed deposits @6%, along with serving Personal loans @14%. What’s the point? Also, it is very clear advice that you should never mix Insurance with Investment. Neither you will get the adequate Sum assured nor you will gain much from Investments due to high expenses. (Also Read: How to use Credit cards wisely?)

• Expecting the Past returns in your future Investments– Equity investments are meant to give you good returns, but also these are the most volatile and sensitive instruments. You cannot expect the same return Year on Year. Growth years are quite infrequent. But when it comes make sure that you are ready to participate with full zeal and decent corpus. It may take 5/10/15 years, but whenever it comes your old and new investments will be benefited together. (Also Read: What is a Good Return on Investment?)

• Not knowing how Investment Assets work – Equity, Debt, Gold, and Real estate, all have their respective features and reasons for growth and fall. Understand how they fit into your requirement before adding one. Don’t listen to Stories around. You are different, your Requirements, Risk appetite is different. (Read: Asset Location is as important as Asset Allocation)

• Goal-focused Investment approach is the Best – This will help in selecting the right Investments, in the right asset class for the right time. Also, the Focus will let you Stay Put for Long. (Also Read: When is the right time to exit your investments?)

• Your Investments should be backed by a Sound Financial plan – Life is uncertain. So not only your investments should be right, but your risk management and distribution strategies should be properly placed. Your Investments should be done and retained with proper logic and reasoning, not just emotions or behavioral biases. (Also Read: When is the right time to start Financial Planning?)

• Don’t Over React, Stay on Track, Follow the Process. –  Investors tend to Over-react to recent happenings. In good times they like to Invest more and in bad times they want to stay away, when the best action would be – Do nothing, just keep investing. Social media is the bad advisor. It’s good for entertaining and networking, not for decision-making. (Also Read: 21 Bad Money Management Behaviors)

So, What’s your Story? Would you like to Share it here? Your Mistakes, Your Experiences, Your Learning? It may help readers to gain a new perspective.