Such a difference is huge! How to explain it?
First of all, the average investor tries to do “market timing”, that is to say, he tries to buy and sell equity funds at the right times. I believe that, for the majority of people, this practice is the best way to get poorer.
Secondly, human psychology is probably involved. It’s a well-known fact that many investors panic when markets crash (think the 2008-2009 financial crisis) and go into overdrive when indices smash highs.
Finally, another factor that explains the underperformance of investors is their tendency to keep too much cash in their portfolio. Remember that stock indices do not contain cash! If you’re aiming for long-term stock market returns, you’ll be fully invested at all times.
Over the years, I’ve gotten into the habit of applying Charlie Munger’s timeless recommended rule of “inverting”, that is thinking against the grain by turning a problem around to analyze it upside down. So, instead of wondering what to do to improve your yields, it would be better to ask yourself what not to do!
Thus, an investor should above all avoid certain particularly costly behaviours:
- Attempt to enter and exit markets at the appropriate times;
- Keep cash;
- Perform a lot of transactions;
- Using debt to invest.
These tips apply to those investing in mutual funds or stock indices. What about investors who buy stocks directly?
Before aiming for home runs by buying a stock, you must above all avoid the biggest pitfalls:
- Avoid companies that do not make a profit or whose business model is not proven. Incidentally, this means that an investor should stay away from turnaround situations or initial public offerings (SPAC or IPO);
- Avoid companies with too much debt;
- Avoid trending securities with exorbitant valuations.
I am convinced that by applying these recommendations, an investor should be able to realize the very attractive returns offered by the stock markets over the long term.
