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The Largest and Most Hidden Cost of Investing

April 12, 2019

I've written in my commentaries, before, about the hidden costs of investing – some which are not readily available to the average investor either from stock brokerage firms, financial planners or mutual fund purveyors. Among those we've previously discussed are items such as bid/ask spread costs, soft dollar costs, commissions (obviously), tax costs, market impact costs, delayed trade costs, management costs and others that might be considered minutiae. However, while these are generally known to many and should be by professionals, perhaps the largest single cost experienced by investors is: "investor behavior cost!"

As I've discussed before and something that many who have attended our classes have learned, there have been several well known studies conducted by Dalbar Research on investor behavior. One of the more interesting ones illustrated that over a period of time when the S&P index (a proxy for the largest capitalization stocks trading in the U.S.) was returning in the neighborhood of 16% p/yr on average, the average investor was earning less than 5% over the same period.

"Ah," you might say: "I have the help of my trusty stockbroker / financial planner / or online services so I can do better." Unfortunately, another thing that the Dalbar research showed was that even with the help of a "professional" such as mentioned, the additional returns that their supposed skill added was less than 1%. Thus, even with expert help, the average investor was only able to earn barely above 5% over a period of time when the stock market was zooming. In this case, a "hidden cost" of almost 10% p/yr!

The conclusion of the study was that it was the investor's behavior – getting in and out of investments or the market(s) at exactly the wrong times, chasing performance or panicking that was the cause of such desultory performance. Now, the investor can be excused for such behavior because typically, investors are human and, as such, are impacted by their own emotions and these emotions are additionally fanned by the media trumpeting the latest craze or predicting doom and gloom and end of the financial world scenarios. This is what drives reader and viewership and what sells, so this is what is going to be fed to the investing public.

Worse though are the various stock brokers, financial advisors, financial planners and financial salespeople who prey upon these investors' emotions, who should, theoretically know better (note, I'm not painting them all with a hugely broad brush, but a very high and significant number of them – as illustrated by numerous industry publications reporting on their behavior). Mostly, what drives these so-called professionals' responses to investor panic (both on the upside as well as the down) is not necessarily any specific evil intent, but rather an enabling response to the investors' panic driven desires. Rather than provide the support and discipline that an investor requires during either manic or depressing times, the advisors give in to the investor's emotions with their own emotions and enable dysfunctional behavior rather than face the prospect of losing a client. At a minimum, this is why investor coaching and a written Investment Policy Statement is so important to a successful investment experience. This is why one of the most important words in a coach’s lexicon is NO!

In sum, when one takes into account the behavior of investors and worse, their equally emotionally driven advisors, and you look at the differential in returns between what the market delivers and what investors are able to reap – even with help, this is a truly staggering cost. So when investors, investment services and advisors concentrate on a few basis points differential in costs between one investment and another – this is literally a case of missing the forest for the trees. What's a difference of a few basis points in cost compared to substantial percentage differences between what an emotionally driven investor receives and what the market(s) actually delivers.

Ultimately, what counts is not investment performance, but rather: INVESTOR PERFORMANCE! Mind your investor emotions or, better yet, work with an "investor coach" rather than an "investor enabler!"

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Frederick C Taylor
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