Are You an Emotional Investor?

Do emotions impact your investment decisions? If so, it could be costing you a lot of money.

Every year, Dalbar, a financial services market research firm, releases a study that compares the performance of the S&P 500 (stock index) and the Barclays Agg (bond index) with the performance of the average investor’s portfolio for each category over different periods of time. It has long been said that this comparison highlights the difference in the investment approaches between the average investors and institutions like insurance companies, mutual funds, and investment banks.

Most financial experts believe that institutions are not as susceptible to the emotional ups and downs of the markets as individuals are. When the market is swinging violently, institutional investors are more likely to stay put while the average investor will try to protect their investments by moving in and out of the market. Average investors in such cases are believed to be investing reactively in accordance with their emotions.

Historically speaking, those moves have proven costly to the average investor.

So, how much does moving in and out of the market cost the average investor? According to Dalbar, the average investor stock portfolio underperformed the S&P 500 index by about 4.3% per year over the last 20 years ending 2011. For bonds, the difference is larger with the average investor bond portfolio underperforming the Barclays Agg index by about 5.6% per year over the same 20 years.

As always, utilizing the expertise of an experienced and objective financial advisor can provide much needed guidance and oversight toward avoiding the common pitfalls of the average investor.

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photo credit: jurvetson