Since 1994, Dalbar Research has conducted their “Quantitative Analysis of Investor Behavior” to understand the effect of investor decisions on their results. In 2016 (the latest data available), DIY investors seeking a balanced 60/40 (equity/fixed) portfolio of mutual funds lagged the market by about 2.75% annually. Looking back over longer time horizons, over the past 5-, 10-, and 20-year periods, DIY investors have been down about 4% annually on average vs. the market…think of this as the fee they pay Mr. Market for the opportunity to manage their own investments.
When I talk with DIY investors, I hear a wide range of motivations for their decision to go it alone…intellectual stimulation and engagement, desire to contribute to their family’s future (particularly among the recently retired), my account is too small for a professional, or the love of “the hunt” for that unicorn stock that’s going 10x in the next 10 weeks. Underneath many of these comments is the theme that a professional advisor just isn’t worth it to them.
Vanguard did a recent study concluding that professional money management could be worth up to 3% annually on returns after fees vs. DIY investing. Interestingly, most of the DIY investors I talk with don’t argue that point. Instead, almost to a person, each believes he or she in the “above average” group of DIY investors who are likely doing as well or better than if they worked with a professional.
This Lake Wobegon effect (“…where all the children are above average”) is technically known in behavioral economics as “illusory superiority“, a quirk of human nature we all share that overestimates our own skills/capabilities in relation to those same skills/capabilities in others.
Often, there can be a small number of data points over time to support one’s illusory superiority. Case in point – I think my golf game is pretty good and I could compete in The Masters. This was confirmed last week when Sergio Garcia took a 13 on #15 during his first round. The guy’s got a Green Jacket and posts a 13 – seriously, I could do that. Now, for anyone who has ever had the misfortune of sharing a cart with me, they’ll confirm for you that me competing at Augusta is about as likely as me competing on the moon. But I can dream, can’t I?
My golfing illusion has no real effect on my life. Unfortunately, for many DIY investors, this quirk of human nature can create an unfounded overconfidence in their investment capabilities and have a significant adverse effect on their irreplaceable wealth over time. There’s always a random trade or a stock pick that reinforces the illusion. But the data says they’re falling behind (on average) vs. the market and suggests working with a financial professional can increase returns after fees (on average).
How do you know if illusory superiority is part of your DIY investment strategy?
Here’s a quick exercise. You get a hot stock/ETF/Mutual Fund tip from CNBC, a subscription newsletter, a neighbor, or a co-worker. When you do the math, it looks like it could be worth about 3% on your total portfolio if it hits. Do you jump on it with both feet? If so, and you think working with a financial professional isn’t worth it…welcome to the human race and our continuing daily struggle with illusory superiority.
To learn more about Dinergy Wealth Management and our commitment to help you care for your irreplaceable wealth, find us at dinergywealth.com.