According to research by Prof. Dichev, from 1926 to 2002, stock investors lagged the stock market by an average of 1.3 percentage points a year, largely due to buying during “hot markets” and selling when stocks performed poorly.
Based on Dalbar data, the typical stock fund investor earned 3.7% annually over the 30 years ending 12/31/2013; a period when the S&P 500 returned 11.1% annually. This means investors who bought stock funds underperformed the market by 7.4 percentage points annually over the past 30 years. Dalbar, a financial research firm in Boston, has updated this frequently cited study every year since 1994.
Part of the large gap (3.7% vs. 11.1% per year) may be due to the fact stock investors often make withdrawals (down payment on a home, retirement needs, buying a car, etc.) when the market is not doing well. Another reason is because a typical mutual fund lags the market by 1.0 to 1.5 percentage points each year because of its expense ratio and internal trading costs.
The chief culprit is investor psychology: the market is flooded with money after it has gone up substantially and then massive withdrawals occur after there has been a moderate or severe decline. This “buy high” and “sell low” mentality makes perfect sense when you consider the power of greed and fear.