Whenever you watch market updates on TV, or think about your investment portfolio, never forget the "yo-yo" analogy. Imagine a man is walking up a hill, playing with a yo-yo. Over the long term he walks up a long hill, so ends up much higher than he started. However, anybody who focused only on watching his yo-yo would see only the wide swings up and down, and probably wouldn't even notice that the man had actually walked up the hill.

The stock market is very similar. Over time, successful investors have to learn to "ignore the yo-yo," and to focus on their long-term goal of "walking up the hill" to investment success.

Unfortunately, many investors miss out on the benefits of this walk because they can't take their eyes off the yo-yo. Every day the media, especially the "talking heads" on TV, are predicting the market will either go up or down because of what happened today. They get especially excited when the market "breaks through trend lines" that they claim are buy or sell signals.

As a result, many investors react emotionally. They therefore get optimistic after hearing good news (when stocks are already higher), and then get pessimistic after hearing negative new (when stocks have already fallen).

This emotional reaction affects both stock and bond investors. According to Dalbar's 2005 "Quantitative Analysis of Investor Behavior," between 1985 and 2004 the S&P 500 Index returned 13.2%, and the Lehman Aggregate Bond Index returned 5.7% (both annualized returns).

Dalbar found that over this same period of time, the average equity investor earned only 3.7%, or only 28% of the return of the S&P 500. And bond investors, who often see themselves as unemotional, didn't do much better. They only earned 2%, which was even less than the rate of inflation over those 20 years.

A great example is how the market reacted after the September 11, 2001 attack on New York. Following the attack, U.S. markets closed for three days. When it reopened on September 14, the Dow Jones Industrials fell 14% over the next five days as investors reacted to the uncertainty of this horrible event.

According to Dalbar, and confirmed by other research showing similar results, the reason most investors don't even match average market returns is primarily due to their emotional reactions to negative as well as positive events.

Simply put, the average investor tends to buy high and sell low, which is opposite the action needed to be successful. Please see my other article in this newsletter, Secrets (?) of Investment Success, for further details on this subject. And while there is of course no guarantee that markets will go up in the future, you certainly won't be able to participate in this potential growth unless you at least try to walk up the hill.

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