How Much Do Retail Investors Really Make?

The allure of the stock market is undeniable. With stories of people turning small investments into life-changing sums, retail investors—everyday people like you and me—are drawn to try their luck. But here’s the kicker: most retail investors don’t make as much as you might think. In fact, many lose money over time. Let's break down why and how much retail investors are really making.

1. The Reality: Most Retail Investors Underperform the Market

The truth is, most retail investors lag behind the general stock market returns. While the S&P 500 has historically provided an average annual return of around 10%, the average retail investor’s returns fall far below that. Studies consistently show that retail investors underperform professional investors and even market indices by a wide margin.

According to data from DALBAR’s Quantitative Analysis of Investor Behavior, retail investors earned an average of just 5.35% annually over the past 20 years. That's nearly half of what the broader market offered. Why does this happen?

1. Emotional Investing: Retail investors often buy and sell based on fear or greed, chasing short-term trends instead of holding steady.
2. Market Timing: Trying to predict the best times to enter or exit the market is notoriously difficult, and retail investors often miss the mark.
3. Lack of Diversification: Many retail investors put too many eggs in one basket, either by investing in just a few stocks or sticking to one sector, increasing their risk.

2. The Few Retail Investors Who Beat the Market

Of course, some retail investors do outperform. These investors tend to be highly disciplined, research-oriented, and strategic. They often:

• Stick to a Long-Term Strategy: Avoiding the temptation to frequently buy and sell helps reduce trading fees and the risk of poor timing.
• Invest in Low-Cost Index Funds: Instead of trying to pick winning stocks, they opt for index funds, which simply track the market.
• Stay Informed: The best retail investors understand market trends, economic conditions, and the companies they invest in. They do their homework.

However, even these investors are rare, and outperforming the market is more often about luck than skill. For most, consistent, modest returns are more realistic than big wins.

3. The Effect of Fees and Taxes

Another often-overlooked factor is the impact of fees and taxes. Every trade comes with transaction fees, and any profits are subject to taxes. Over time, these costs can significantly eat into an investor's gains. Even a small fee, when compounded over years of trading, can reduce overall returns by a significant amount. Here's a breakdown:

4. The Role of Passive Investing

Many experts now recommend passive investing as a way to mitigate the underperformance seen among retail investors. Instead of actively trying to beat the market, passive investors:

• Buy and hold low-cost index funds: This strategy eliminates the risk of poor stock picking and high fees.
• Rebalance portfolios annually: Keeping a balanced portfolio ensures that risk stays in check without constant trading.
• Avoid emotional trading: Since passive investors are less involved in daily trading, they're less likely to make rash decisions based on short-term market movements.

5. Retail Investors During Market Crashes

It's during market downturns that retail investors tend to lose the most. Instead of staying the course, many panic and sell at a loss. Take, for example, the 2008 financial crisis or the 2020 COVID-19 crash. In both cases, retail investors pulled their money out at the worst possible times, missing the eventual market rebound. According to studies, investors who stayed in the market saw their portfolios recover, while those who sold suffered permanent losses.

6. Day Trading: The Biggest Risk

Retail investors who engage in day trading—buying and selling stocks within a single day—are even more likely to lose money. Studies show that over 90% of day traders lose money, often within the first few months of trading. Day trading requires significant skill, experience, and the ability to manage risk, something that most retail investors simply don’t have.

7. The Psychological Toll

Finally, there’s the emotional and psychological toll that retail investing can take. Many retail investors enter the market with dreams of quick riches, only to face the harsh reality of losses. This can lead to frustration, stress, and poor decision-making. The constant ups and downs of the stock market can wear down even the most patient investor.

Conclusion: The Retail Investor's Paradox

The paradox of retail investing is that while the market offers significant long-term gains, most retail investors fail to capture them. This is due to emotional decision-making, poor timing, and the drag of fees and taxes. For most, a passive, diversified approach—rather than trying to outsmart the market—offers the best chance of success. Investing isn't a sprint; it's a marathon. Those who are patient, disciplined, and willing to ride out the market’s ups and downs will fare the best.

But at the end of the day, the answer to “how much do retail investors make?” is simple: It depends on how they invest.