Why "dead" investors outperform the living

[UNITED STATES] "Dead" investors frequently outperform the living, at least when it comes to investment returns. A "dead" investor is an inactive trader who follows a "buy and hold" investment strategy. According to experts, this often results in larger returns than active trading, which has higher fees and taxes and is based on spontaneous, emotional decision-making.

This phenomenon isn’t new. Legendary investors like Warren Buffett have long advocated for a patient, long-term approach. Buffett’s Berkshire Hathaway, for instance, has famously held stocks like Coca-Cola and American Express for decades, reaping substantial rewards from compounding growth and avoiding the pitfalls of market timing.

According to investment experts, doing nothing produces better results for the ordinary investor than actively managing one's portfolio. Brad Klontz, a licensed financial planner and financial psychologist, believes that human conduct, rather than government policy or firm activities, poses the "biggest threat" to investment returns. "It's them selling investments when they're panicked, and buying when they're all excited," said Klontz, managing principal of YMW Advisors in Boulder, Colorado, and a member of CNBC's Advisor Council.

“We are our own worst enemy, and it’s why dead investors outperform the living,” he said. Despite market fluctuations, dead investors continue to "own" their equities.

Market history underscores this resilience. For example, during the 2008 financial crisis, the S&P 500 lost nearly 50% of its value, but investors who held on saw their portfolios fully recover by 2013—and then triple over the next decade. These recoveries often reward patience, but the emotional toll of downturns can cloud judgment, leading many to sell at the worst possible moments.

Stocks have always recovered following a dip, and have always reached new highs, according to Klontz. Data demonstrates how destructive bad habits may be to the buy-and-hold investor. According to DALBAR, which undertakes an annual investor behavior survey, the typical stock investor's return in 2023 will be 5.5 percentage points lower than the S&P 500 stock index. (DALBAR said that the typical investor earned approximately 21%, while the S&P 500 returned 26%.) The subject also extends over greater time periods.

Morningstar reports that between 2014 and 2023, the average mutual fund and exchange-traded fund investor in the United States earned 6.3% per year. However, the average fund generated a total return of 7.3% throughout that time, according to the findings. That discrepancy is "significant," according to Jeffrey Ptak, managing director of Morningstar Research Services. It means investors lost approximately 15% of the profits on their money over a ten-year period, he noted. He noted that the discrepancy is consistent with previous periods' returns.

"If you buy high and sell low, your return will lag the buy-and-hold return," according to Ptak. "That's why your return fell short."

Emotional tendencies to sell during downturns or invest into specific categories when they are peaking (think meme stocks, cryptocurrency, or gold) make sense when considering human evolution, according to researchers.

Recent trends highlight this behavior. The 2021 meme stock frenzy, driven by social media hype, saw retail investors pour money into companies like GameStop and AMC, only for many to suffer losses when the bubble burst. Similarly, Bitcoin’s volatile swings have lured investors in during peaks, often leading to regret when prices corrected sharply.

"We're wired to actually run with the herd," Klontz added. "Our approach to investing is actually psychologically the absolute wrong way to invest, but we're wired to do it that way." Market movements can also elicit a fight-or-flight response, according to Ritholtz Wealth Management's chairman and chief investment officer, Barry Ritholtz.

"We evolved to survive and adapt on the savanna, and our intuition ... wants us to make an immediate emotional response," Ritholtz told me. "That immediate response never has a good outcome in the financial markets." Experts warn that these behavioral blunders can result in significant losses.

Consider investing $10,000 in the S&P 500 from 2005 to 2024. A buy-and-hold investor would have received nearly 72,000 at the end of those 20 years, for a total of 10.472,000 and 10.433,000, according to the findings. So, by missing the greatest 20 days, an investor would only have $20,000. Buy-and-hold does not imply 'do nothing'. Obviously, investors should not do nothing.

Technology has made passive investing more accessible than ever. Robo-advisors and low-cost index funds allow even novice investors to adopt a hands-off strategy with minimal effort. Platforms like Vanguard and Fidelity offer automated tools that replicate the “dead” investor approach, reducing the temptation to tinker with portfolios during market volatility.

Financial planners frequently propose simple activities such as assessing one's asset allocation (to ensure it is in line with one's investment horizon and goals) and rebalancing on a regular basis to preserve the stock and bond mix. Balanced funds and target-date funds can help investors automate these processes.

According to Ptak, these "all-in-one" funds are well-diversified and handle "mundane" chores such as rebalancing. They need less dealing on the part of investors, and reducing transactions is a general key to success, he said.

"Less is more," Ptak wrote.

(Experts recommend against maintaining such funds in non-retirement accounts for tax reasons.)

Routine is also beneficial, according to Ptak. He said that this entails automating as much of the saving and investing as possible. Contributing to a 401(k) plan is a good example, he said, because employees contribute automatically each salary month.