Why Most Retail Investors are Underachievers
According to the DALBAR, Inc. report: "Quantitative Analysis of Investor Behavior," most retail investors:
Feel twice the pain of a dollar lost than pleasure of a dollar gained. This is referred to as "Myopic Loss Aversion" by experts in the field of Behavioral Finance. There's nothing wrong with having a heightened sensitivity to the possibility of losing money, as long as it doesn't interfere with the ability to make good investment decisions. But the data shows that most investors do let this loss aversion get in the way.
Focus more on avoiding down markets than participating in up markets. (For example, a retirement plan invested only in money market funds.) Which is worse: being invested in a declining market, or not being invested in a rising market? Answer: they're equally bad. But most investors don't see things that way. They don't view opportunity cost (being in cash when the market is rising) as somehow less real than actual paper losses. In fact, a paper loss is a paper loss regardless of which way the market goes.
Fear making any mistakes even though professional investors make plenty. This fear is often paralyzing at exactly the wrong time. The markets are constantly presenting us with opportunities to buy low and sell high. But investors who are too fearful of losing money often balk at buying when prices are cheap. This leads to severe under-performance by retail investors in general.
Project recent investment performance, bullish or bearish, to infinity. Finance experts call this "extrapolation." It comes from the conventional wisdom that says what happened in the past is likely to continue to happen in the future. This is true for many aspects of our lives, but in the world of investing, it's a dangerous misconception. There is no evidence to support the claim that stocks that have gone up recently will continue to go up, or vice versa.
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