The "dead investor" strategy: how to train yourself to restrain emotions on the market

The average investor has become less likely to make behavioral mistakes and less likely to make unnecessary trades. That's according to the latest "Quantitative Analysis of Investor Behavior" report from independent research firm DALBAR. But analysis over the long horizon shows that on average, investors are lagging market benchmarks in terms of returns. And the reason for this is not the wrong choice of financial instruments, but behavior.

"Quantitative Analysis of Investor Behavior" (QAIB) is a study that DALBAR has been conducting since 1994. In it, its analysts try to answer a simple question: how does an investor's own behavior and decisions prevent or help him or her from making money in the market? To do this, DALBAR takes data on inflows and outflows from mutual funds, reconstructs the "average trajectory" of the money and compares the result to a benchmark. DALBAR analysts explain the difference by the behavior gap, or behavioral gap.

In its latest survey, DALBAR showed that average equity investors in 2025 nearly caught up with the S&P 500 index in terms of returns, lagging by just 0.72 percentage points. For example, the S&P 500 Index delivered a total return of 17.88% annually, while the average investor earned 17.16% on stocks.

Last year, that difference was one of the smallest since 1985. But DALBAR's analysis for the 30-year period shows: the average return on the S&P 500 was close to 10% annually, while the private investor got about 4.2%. The main reason for years of underperformance is the behavior of market participants, not bad instruments, DALBAR says.

DALBAR experts formulate several typical patterns that lead to a behavior gap. These are panic selling, overly optimistic buying and market timing attempts, when an investor tries to guess the best times to buy and sell assets based on forecasts of future growth or decline.

In an earlier report, for 2024, DALBAR analysts emphasized that investors are often very active and make a lot of trades, leading to mistakes that eat up some of the potential returns. In addition, many miss the recovery in the markets.

There is quite a market explanation for the lagging behind benchmarks of excessively active market participants: frequent transactions lead to the fact that commissions eat up a serious part of investment income. But the very reason for such excessive activity lies in the peculiarities of behavioral psychology. We feel losses about twice as much as equal-sized gains because our brains react to drawdowns as threats rather than market fluctuations. This pushes investors to sell at the bottom or buy at the peak, and to herd behavior.

Add to that overconfidence in yourself and your skills. This, as Oninvest wrote, makes you take more unnecessary risks and pushes you to more active trading and more deals.

Similar to QAIB, a study by researchers from the University of Iowa and the University of Nebraska-Lincoln found that investors lost an average of 1.56 percentage points per year in returns due to poor timing of entry and exit from an asset.

Those who practically do not interfere with their portfolios were better off. Such inactive investors are nicknamed "dead investors" because, in other words, they do not interfere with the portfolio's performance. And they are as close as possible to the S&P 500 index in terms of returns.

Based on what the DALBAR reports capture as the source of the behavioral gap, there are three practical conclusions for the investor.

- The strategy of the "dead investor", who does not touch the portfolio regardless of what happens in the market, essentially teaches discipline. On the contrary, active management, frequent trading, and attempts to guess the "perfect exit and entry" statistically increases the chance of falling behind the market.

In practice, you can set clear rules for yourself, such as goals, risk tolerance, entry and exit rules, portfolio rebalancing criteria, or even a limit on the number of trades per day or per week. These, if followed, reduce the detrimental influence of emotions on investment decisions.

- The investor can make precommitments (precommitment). They reduce impulsive decision-making because the person switches from a reactive system, which is the responsibility of the "emotional" parts of the brain, to a planning and logical one before the stressful situation occurs. This method is considered one of the best ways to protect against the negative effects of psychological biases.

For example, you could spell out that if my portfolio declines in value by 20% from its peak, I do not sell or reduce positions. Instead, I revise the investment plan after seven days of the "cooling off period" and buy an index fund for another 10% of the annualized return.

- A successful trade is not an indicator of the success of the entire portfolio, nor is it an indication that the investor has timed the market well and knows the market. It can be a fluke and should not be relied upon.

This article was AI-translated and verified by a human editor