Average Investors – Why they don’t get great returns and how you can do it better!

The investment market is a place of hopes and fears. Many average investors hope to make a lot of money, sometimes to make it very quick. But they also fear to lose their hard earned money and some really do very quick. The most, I think, don’t get great returns, in the best case, mediocre returns. The question is, why and how you can do it better?

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Not everybody is interested in the financial market and in investing. The ones who are, the average investors, hope to make agood return, but mostly never will. It’s interesting that you can find a fraction that believes nobody can beat the market. Therefore they don’t even try to do it. These people don’t argue based on their own experience. They just follow the opinion of some “experts” who aren’t practitioners, but only made theoretical researches. For them, every investor who beats the market, not once, but on average over a longer period, is just lucky and must have insider information. And everybody who believes he can do it, too, is overconfident.

I don’t understand

I really don’t understand why so many people, especially here in Germany, are so convinced about their own mediocrity. Sure, not everybody will make it to the very best, but when you don’t try it, you absolutely won’t. Maybe this is a protection against failure and disappointment. And all too often, it’s an argument for not doing any work.

There is a second thing I don’t understand: Why do these people ignore the experience of successful investors. For example, Warren Buffett said that you don’t have to be extraordinary to achieve extraordinary results. That means that every average man and woman can beat the market. Or does Buffett lie? Furthermore he thinks that the “small” investor has a huge advantage over those who invest big sums of money.

If Buffett is right, and I’m convinced he is, then there must be reasons why so many average investors don’t get great returns or beat the market over the long run. So, let’s try to find some.

Why many average investors don’t beat the market

First of all, if you believe you can’t beat it, you never will. So, many of your success depends on what you’re believing and therefore your action. Another obvious reason for not beating the market is when you invest in the broad market. A high grade of diversification can only bring you mediocre returns. If you invest in the broad market, you get the return of the broad market and surely can’t beat it. So, when you prefer to invest in ETFs or index funds, you will never get extraordinary results. And that’s okay. But please don’t believe that others can’t do it just because you can’t or don’t want to do it.

More reasons

Besides these obvious reasons which aren’t very helpful, there are some more, which prevent average investors from succeeding and beating the market. These reasons are based on the strategy they have and on the way they think about investing. Many average investors following the wrong strategy or even don’t have one.

Not having any strategy is a very risky game and your success is only based on luck. Water on the mills of those who believe investment success is based on luck. And also of those who believe that average investors can’t be successful on the investment market.

I admit that it’s difficult when you’re new on the financial market. There are so many different informations out there, so many advisors and so many different strategies that you can’t really know which one to follow and which one to resist. Facing this situation, many average investors do what seems obvious. They invest like everybody else. It’s part of our nature. It’s part of our instinct to survive. Robert Cialdini says:

“We determine what is correct by finding out what others think is correct. We view a behavior as correct in a given situation to the degree that we see others performing it.”

What everyone else is doing

Based on this behavior, the new, but also experienced investors who never changed their investment habits, start listening to the mass and invest in the things, the mass is investing in. Nowadays this contains investing in ETFs, cryptocurrencies, binary options etc.. But it also means, regarding stock investments, investing in companies that are everyone’s darling, like Netflix, Facebook, Tesla etc. These companies may be good or great ones. And they will be good or great for a long time. But the problem is that when everyone else likes them, these companies are all too often very expensive and only available at a premium to intrinsic value. Buying too high contains the risk of losing, because it’s more likely that the price of an expensive company will decrease than increase much more.

Surely, you can win on this strategy. But you don’t know when the peak is reached. So you really don’t know, when to sell. Many investors miss this point and sell when it’s too late. This means, they sell with just a little return or maybe a loss.

What’s really a pity is the fact that all these investors don’t listen to those who are very successful and share their knowledge with all the others on this planet. They don’t listen to those who experienced success on not following the herd. They rather listen to the “experts” who don’t succeed on the financial market or even don’t invest in, but have researched the market from the outside and have written long studies about their theoretical conclusions.

A young investor once said to me that he rather believes in studies than experience. On this he based his investments and that’s why he’s satisfied with mediocre returns.

Don’t do what everyone else is doing

In the investment world, following the herd is the worst you can do. It’s just like Seth Klarman said:

“Over the long run, the crowd is always wrong.”

Doing what the crowd is doing can nothing but bring you mediocre or bad returns. The crowd tends to invest in everyones
darling (which is obvious), to buy too expensive, to sell to cheap, to ignore bad signs, to be greedy, and to be fearful.

So, when you want to succeed on the financial market and in my case the stock market, you have to go against the tide. Okay, it’s easier said than done. But it’s possible. And it’s possible for everybody. First of all you have to ignore the crowd and their opinion. Make your own conclusions, even if you stand alone. Walter Schloss said:

“Don’t be afraid to be a loner but be sure that you are correct in your judgement.”

What you can do to beat the market

I hope, you’re on “Invest like the Best!”, because you’re not satisfied with mediocre returns, but rather interested in beating the market. If you want to do this, you have to implement some important behaviors in your investment habits.

First, and this is maybe the hardest one, you have to invest some work in your decision process. You can’t succeed without any work. Working means two things. You have to think on your own and you have to research well. Start by thinking about the right strategy for you. Write it down. Make a list of all criteria that an investment has to fulfill before you put any money into it. You can take my “Investors Checklist” as a little help, if you want to invest in the stock market. You will find the sign up form at the bottom of any of my pages.

Circle of Competence

Make clear, where your competence is. Which financial products, which sectors and companies are you really able to understand? Concentrate yourself on this Circle of Competence and only search for financial products within this circle.  The probability to invest successfully in financial products you understand is much higher than investing in something you don’t understand. You will find enough great opportunities within. So don’t be afraid of losing a chance. Losing a chance is much better than losing money.

Sweet Spot

Within this Circle of Competence search for the one that meets all your criteria you set for a good or outstanding product. When you invest in companies, like I do, only buy companies which fulfill all your criteria. It’s of absolute importance. Ted Williams, the great baseball player from the Boston Redsocks, would call it the “Sweet Spot”.

Financial Statement

Don’t only read or watch what you can find in the news. Read the financial statement, too. Make yourself a picture of what the company is doing and if you think it could be successful in the next 10+ years. I read through the last reports extensively and less extensive through older ones. But I always read the reports of the last 10 years. Look at the figures of the last 10 years. Be sure, they meet your criteria. Look for continuity, especially for continuous growth. If there is an outbreak, try to understand, why, and be sure that this was a unique event.

Intrinsic value

Calculate the intrinsic value of the company. It’s absolutely important for your success. The market price mostly don’t reflect the intrinsic value. In the short term, the price is all too often too high or too low. The latter is your chance to make a lot of money. But you have to buy with a discount to intrinsic value. Over the long run, the market price tends to reflect intrinsic value. If you buy below, chances are high that you’ll get a decent return. But if you buy too high, chances are also high that you’ll lose money.

Margin of Safety

The discount of market price to intrinsic value not only is your chance to make a great return. It’s also your insurance against loss and failure in calculation and estimation. Buying below value is your margin of safety. The margin of safety reduces your risk when investing while it increases your chance to beat the market simultaneously.

As Warren Buffett said:

“The greater the potential for reward in the value portfolio the less risk there is.”

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