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Investing Basics

Don’t Flatter Yourself

"In 2010, the average domestic fund investor saw a return of 11% less than the annual return for the fund."*

Articles by Betterment Editors

By the Editorial Staff
Betterment Resource Center  |  Published: January 19, 2012

We’ve shared this stat. in the past. I’m sharing it again because it’s astounding – and such a good example of how humans are predictably irrational.

 

Why Do We Make Such Bad Decisions?

Overconfidence bias: Ever thought you were better than most people at something? Like bargain shopping, driving, or cooking? It turns out that we humans all tend to think we’re above average in some situations where we’re likely just average (or worse!). Investing is no different from those other skills we inflate – many people think they can earn above-average returns through their superior abilities (despite much evidence to the contrary). The reality is that trading is hazardous to your wealth, and studies have shown that active stock-pickers generally perform worse than passively selected index funds that track market averages. Many people think they can outperform the market, but they rarely do in the long term.

Sticking with what we know: In many areas of life, the familiar is important to our decision making–but in investing, going with what we know can send us on a path that diverges greatly from the most effective way to manage a portfolio. The best approach is to diversify your investment.

So, how do you avoid falling victim to behavioral biases that can take your portfolio off the road to long-term growth? The answer is fairly simple: stop flattering yourself! Take yourself – and your irrational decisions – out of the equation.

*Read all about the performance gap on My Money Blog.

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