FREE NEWSLETTER

Are Investors Idiots?

WALL STREET loves to depict everyday investors as fools. But there’s scant evidence this is true—and plenty of reason to question Wall Street’s motives in perpetuating this myth.

No doubt about it, many individuals make investment mistakes. But so, too, do many professionals. Indeed, if everyday investors were so incompetent, it would presumably be easy for professional money managers to take the other side of their misguided trades and thereby beat the market. Yet legions of data prove that most money managers trail the market averages. That suggests most individuals aren’t getting taken to the cleaners by the pros—and they’re probably doing okay.

This makes sense: The markets are reasonably efficient, meaning stock and bond prices reflect all currently available information. Even if amateur investors don’t know what they’re doing, this market efficiency protects them, because most of the time they’re getting a fair price. So what could cause amateurs to do far worse? There are three potentially devastating errors.

First, amateurs may trade too much, racking up hefty costs that drag down their returns. Second, they may fail to diversify, so they’re badly hurt when one of their stock picks proves to be a dud. Third, everyday investors may panic when the stock market dives, selling out when share prices are deeply depressed. While some investors do indeed make these three mistakes, such errors don’t seem to be widespread.

But what about the famous Dalbar study, which purports to show that mutual fund investors garner results that are so much worse than the market averages? The Dalbar study is frequently cited as evidence that everyday investors are incompetent. But the study’s methodology has also been widely criticized, including by HumbleDollar’s editor when he wrote for The Wall Street Journal (2004), the Finance Buff’s Harry Sit (2011), The Wall Street Journal’s Jason Zweig (2014), Michael Edesess et al (2014) and the American College’s Wade Pfau (2017).

If all this is true, why does Wall Street persist in denigrating everyday investors? Because it’s in the Street’s best interest. If Wall Street can persuade investors that they’re unfit to manage their own money, the Street benefits—because investors are more likely to pay for high-priced advice.

Next: Hire an Advisor?

Previous: Money Buy Happiness?

Have a question or comment? Add it here:

Free Newsletter

SHARE