Reason #3: Investing or Speculating?

In my Retirement Coach Strategy of the Week this week, we’re going to move on to the 3rd reason why I believe retirees earned 77% to 90% less than market averages each and every year over the last 20 years.

To refresh your memory, here’s what Dalbar, Inc.’s study revealed for the 20 year period ending in December, 2008:

  • The average annual return of the S&P 500 Stock Market Index over that 20 year period was 8.25% (including dividends reinvested). So, if you did nothing other than invest in the S&P 500 Index, you would have averaged 8.25% per year minus the cost of the index fund.
  • However, according to Dalbar, Inc., the average annual return of the “average” equity mutual fund investor (not investment, but investor, i.e. a person) over the same 20 year period was 1.87%
  • The average annual return of the Barclays Bond Market Index: 7.43%
  • Yet, the Average annual return of the “average” bond fund investor was (.77%) (So that we’re clear, that’s 77/100ths of 1%!)

What you can’t help but take away from those statistics is that, while it makes all the news, markets or bad investments are not our biggest problem.

The big problem is investor behavior which is driven by their “strategy” or lack thereof.

Think about that for a moment. Something that we all can control is what our biggest problem is.

So, let’s jump into the 3rd problematic investing behavior that we all can control:

Investing or Speculating?

The 3rd reason why I believe the average investor earned 77% to 90% less than the market averages each and every year over the last 20 years is crossing the line from investing into “speculating”.

Well, what does that mean?

A speculator chases price trends.

An investor chases value, and what investors know that speculators never know is that price and value are inversely related.

So, for example, think back to 2002 when high tech internet stocks were going through the roof.

As their prices rose, the interest in them rose dramatically at the same time. People continued to pour more and more money into them. And, nobody was buying what was then referred to as “old economy stocks” like Berkshire Hathaway.

Speculators

Speculators always respond to price. And, this means on the way up and on the way down. They believe that the risk of a particular investment goes down as the price goes up. So, as the price goes up, the risk appears “lower” to them.

Conversely, as the price of an investment drops, they believe the risk goes up thus leading them to sell it!

Let me repeat that because you definitely want to make a note of it.

Speculators always respond to price. And, this means on the way up and on the way down. They believe that the risk of a particular investment goes down as the price goes up. So, as the price goes up, the risk appears “lower” to them.

And, conversely, as the price of an investment drops, they believe the risk goes up thus leading them to sell it!

An investor, on the other hand, migrates toward an investment whose price has fallen because an investor knows that as price goes down, the value of the investment goes up.

Real Estate

Another example of this is real estate over the last 5 years. There was a good stretch there where anyone would pay any price for a condo in Boca Raton or Naples Florida because they believed that the price would double in 3 years!

And, as prices rose, the fury got greater and greater.

Was that investing? Or was it speculating?

Well, we all know that it was speculating. And, look what has now happened. You’re lucky if you can get out of one of those things for 50 cents on the dollar today!

The bottom line is that one of the gravest mistakes which led investors to earn 77% less each and every year over 20 years is speculating and making investment decisions based on chasing price movements instead of pursuing long term value and, thus, “investing”.

There’s a huge difference.

Stay tuned for Reason #4 next week. I hope you’re taking good notes and paying particular attention to the big picture.

Committed To Your Relaxing Retirement,

Jack Phelps
The Retirement Coach

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