There are number of ways to think about let-markets-work-for-you advice, but we'll focus on two. First, looking at how different markets work over time gives us insight into how we should allocate our investments. History has shown us that global stock markets have worked better at growing our money and beating inflation versus cash and bond markets. For investors looking to grow their investments and outpace inflation-which is pretty much all of us--we will likely need to have some allocation to stocks in our portfolios.
Second, in trying to capture the returns that stock markets offer, we must stay invested in those markets. The same is true for bond markets. Stock and bond market returns are typically positive on an annual basis, so staying invested in those investments gives us the best opportunity to let the market work for us.
While this advice seems simple, our human nature can often get in the way. Behavioral economists have shown that losses impart twice as much pain as the joy we feel from a similar sized gain. Because of this, we typically feel the urge to sell our investments when markets are falling.
Consider the fourth quarter of last year. It seemed every news story was about how interest rates were rising too quickly and that it was going to potentially cause a recession. Stock markets fell very quickly on fears that the news may be right. How did this news make us feel? The urge to sell is high when markets are falling because that pain of loss is so strong.
But what happened next? Stocks actually advanced in the following four months and a few market indexes reached new all-time highs. What would have happened if we listened to our inner voice that told us to sell? We would have surely missed out on the sizable gains that followed.
We aren't alone in our struggle to let markets work for us. One of the important studies on investor behavior is called the Dalbar Quantitative Analysis of Investor Behavior. The 2019 release of that annual study continued to find that investors aren't earning the returns that the markets offer. For example, over the past 20 years ending December 31, 2018, the S&P 500 Index earned an annualized return of 5.6% while the average investor in stock mutual funds earned only 3.9%. The study suggests that investors lost that 1.7% (about 30% of the return available to them) to poor investment behavior like market timing and return chasing.
Basically, the study confirmed that investors, on average, aren't letting markets work for them. This is why we stress the importance of letting markets work for us. When investors leave 30% of the potential return available to them on the table, it's not marketing buzz to call our belief powerful. Letting markets work for us is vital to our investment success.
Index returns do not reflect payment of advisory fees or other expenses associated with specific investments. Average investor returns captures realized and unrealized capital gains, dividends, interest, trading costs, sales charges, fees, expenses and any other costs.