The decade-long bull market has produced some huge gains, including a 10-year return of 183.6% for the SPDR S&P 500 ETF Trust (NYSE: SPY).
Unfortunately, it’s likely many individual investors missed out on a large portion of those gains.
A recent study by DALBAR found that individual investors averaged a 3.69% annual return over a 30-year period in which the S&P 500 averaged 11.1% returns annually.
A similar study by Morningstar found that individual investors averaged a 6.1% return over a 10-year stretch, while passive mutual funds averaged 7% returns over the same period.
In 2018, active fund managers — professional managers that often manage millions or billions of dollars — underperformed the S&P 500 for the ninth consecutive year.
S&P Dow Jones Indices found that a whopping 92% of stock-picking managers have underperformed the S&P over the past 15 years.
Why Are Investors Missing Out?
More than one theory exists about why it’s so difficult for individual investors to beat the market. A number of psychological biases, such as loss aversion, social conformity and confirmation bias, are constantly working against the individual investor. Individual investors often chase top-performing stocks, often buying at the worst possible time. Some investors gamble on low-quality stocks because they have a gambler’s mentality, seeking to get rich quick.
One of the major reasons why individual investors underperform is because the odds are stacked against them.
While the S&P 500 generates relatively consistent positive returns, those returns are far from uniform. A 25-year study by Longboard Asset Management of Russell 3000 stocks found that 64% of the 3,000 stocks underperformed the overall index during the 25-year period. At the same time, only 25% of the 3,000 stocks accounted for all of the index’s gains during that time.
Education, Information Are Key
If professional stock pickers are struggling to beat the market, individual retail investors have an even steeper hill to climb.
PreMarket Prep co-host Dennis Dick says one of the most difficult things about individual retail investors attempting to extract alpha from the market is that alpha is a zero-sum game.
“The majority of the daily volume is professionals — prop firms, institutional investors and high frequency traders. Professionals are very informed. They pay to be informed,” said DIck, who is a prop trader and equity market structure analyst at Bright Trading.
Many individual investors want to avoid spending money on information.
“Imagine starting a business trying to generate revenue without incurring any expenses. This would be a monumental task. But when an individual investor opens an online brokerage account for free and expects to just start trading and beating the market, that is exactly what they are trying to do,” Dick said.
Plenty of retail investors jump into the market expecting to be successful and skilled right out of the gate, he said.
“It typically takes six months to a year of education and trading experience before you're expected to make money,” Dick said.
“At a bare minimum, if you expect to beat the market, you need to be educated and you need to be informed.”
It can be extremely difficult and dangerous for individual retail investors to attempt to beat the market if they are inexperienced and uninformed.
Fortunately, investors don’t need to beat the market to make impressive long-term returns. By investing in a low-cost S&P 500 index ETF, such as the VANGUARD IX FUN/S&P 500 ETF SHS NEW (NYSE: VOO), investors have easily tripled their money in total returns over the past nine years.
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