We all want to be wise with our money, but doing so is a lot harder than most people realize. Studies show that most people save too little, withdraw too much, and make matters worse by buying and selling investments at inopportune times.
The past nine years have masked a lot of financial mistakes. We’re in the second longest economic expansion in history and have had average stock market gains north of 15% per year. We don’t know what tomorrow will bring, but it’s probably smart to assume that the next five years won’t be as easy. That makes now a perfect time to think big picture, get organized, and correct any deficiencies.
There are lots of financial errors one can make, certainly as it pertains to personal finance. But there are certain mistakes that have the power to upend a lifetime of otherwise good financial stewardship. We call these the pivotal mistakes that cripple family wealth, and we want to help you avoid them.
The Pivotal Mistakes
1) Chasing Performance
Studies show that individual investors substantially underperform basic indexes because they are consistently bad market timers. A 2016 study by DALBAR showed that for the 20-year period ending 2015, the average individual investor (non-professional) in a stock mutual fund underperformed a simple index by almost 3.0% per year, due entirely to poor buy and sell decisions.
Financial flows into and out of mutual funds, closed-end funds, and exchange-traded funds confirm the DALBAR study. As you can see in Chart 1 below, investors put money in and take money out of the stock market based on past market performance. The blue line is S&P 500’s quarterly performance, while the black and red bars are investor money flows into (black bars) and out of (red bars) the stock market.
Market performance (1) consistently precedes stock investor money flows (2). That is, investors consistently chase past performance to their detriment.
2) Falling for the Pitch
Wealthy individuals are often inundated with meeting requests and phone calls from random brokers, neighborhood advisers, and big-name firms, all with sales pitches meant to excite and impress. There is big business for firms and advisers that offer a lot of varied products and strategies. One of their products is always working, so there is always something to sell. These “opportunities” are pitched on recent past performance, but they often don’t turn out so well.
Chart 2 below shows the impact of the hiring and firing decisions of institutional investors. The blue bars on the left show the past relative outperformance of hired managers over just fired managers. The red bars on the right show that the performance of these newly hired managers subsequently trails the very managers the institutions fired–and performance gets worse over time.
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