Are you underperforming the market?
A lot of investors are – value investors included. Since 2009, the depth of the Great Financial Crisis, the NASDAQ is up 273%. If you haven’t beaten the NASDAQ’s performance over the same period, this article is for you.
Don’t feel too bad if you’ve missed the mark. From 1993 to 2013, small investors have dramatically underperformed the market. While there’s a whole host of high-performance investment strategies that can definitely help small investors crush the market, the average investor earned less than half of the market’s return.
Returns are much worse than only half of the market’s return. While the Standard & Poor's 500 returned about 9% compounded annually, the average investor earned just over 2%.
Why the terrible results?
Part of the problem is investment “advisers” (aka “salesmen”) who push poor products, such as expensive but poorly performing mutual funds –Â but small investors suffer from three crippling bad habits.
The first is failing to focus a high-performance investment strategy. Here’s the worst-kept secret in investing: There are outstanding investment strategies out there of which any small investor can take advantage. Unfortunately, most investors lack direction. They flip from one strategy to another, buy a couple of stocks from a number of different strategies (failing to understand proper portfolio construction) or fail to look for stocks that fit a particular strategy at all. Even worse, many individual investors have fallen into the Warren Buffett trap by trying to buy the same sort of companies he does.
All of this is a recipe for terrible long-term returns. Since 2010, I selected net-net stock investing as my bread and butter. This strategy is probably the most widely studied of Graham’s classic investing strategies and consistently produces the highest returns of any deep value strategy out there. After stumbling onto the strategy in 2010, I spent the next few years dissecting it to figure out what makes it tick and how I could exploit it to earn the best returns and retire early. Since then, I’ve shared a lot of what I’ve learned in order to help others do the same.
My decision really paid off – allowing me to earn a compound annual return over 25%. Still, there are other great strategies out there, strategies that have a history of beating the market by wide margins. They all have their roots in solid Graham-styled investing and are generally referred to as deep value.
Why don’t more investors select high performance strategies? In short, investor psychology. A lot of the highest performance strategies focus on buying ugly, beaten up, terrible companies. They’ve often lost over half of their revenue and have seen their stock prices drop by 80% or 90%. It’s pretty obvious why these stocks trigger an investor’s gag reflex. Unfortunately, a great business and a great investment are not the same thing.
As John Templeton said, if you invest the way everybody else invests, you can’t expect to beat the market. Solid investment requires following a great strategy and to do so often requires buying when other investors are running from the stock. To earn great returns, learn about investor psychology and strengthen your emotional intelligence so you can leverage the best deep value strategies available.
The third crippling mistake small investors make is failing to stick to an investment strategy. Just because an investment strategy produces outstanding returns does not mean that the strategy will beat the market or even produce positive returns each and every year. Investors either don’t understand this or lack the psychological strength to stick to a winning strategy when it underperforms.
Unfortunately, investors tend to jump ship right before a strategy starts to regain its footing and produce great returns again; and they tend to transition to hot strategies just before those strategies start to underperform. It would have been much better to just stay put and wait for the strategy to start producing market crushing returns again. Consistency is key.
Earning market-beating returns is much easier than most investors think, but it does take a shift in thinking and some personal development. Selecting a high performance deep value strategy, developing strong emotional temperament and sticking to that strategy through thick and thin are all part of it. Ultimately, if you’ve suffered a history of poor investment returns, then you need to radically rethink what you’re doing.
