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Investor Behavior Continues to Decimate Long Term Portfolio Returns

By: Richard Feldman

By: Richard Feldman, CFP®, AIF®, MBA

The journey from the October 2007 peak in the equity markets to the lows of March 2009 was an emotional rollercoaster for most investors. The journey was part of the worst recession we have seen since the great depression and emotions were driving a lot of investment decisions made over the past year and three quarters. Emotion tends to reek havoc on long term investment results particularly when the emotion you feel suddenly turns to panic and that is exactly what many investors did in the first quarter of 2009.

We have seen study after study detailing how the average investor receives only a fraction of long term index investment results due to poor decision making regarding buying and selling of mutual funds. If you look at the data provided by the Investment Company Institute’s weekly cash flows for 2009, you see a similar pattern that has played out many times – investors selling equity funds at a particularly inopportune time as the chart below shows you.

You can see from the sequence of inflows above that investors in equity mutual funds sold billions of dollars of equities at the bottom of the market cycle in March. It is extremely difficult to make up for that sort of headwind when looking at long term results. In order to breakout the performance of the S&P 500 growth of a $1 return pattern, please review the table below of monthly returns for the S&P 500:

In a few years when you review these results most people will fail to remember how the first few months of 2009 actually played out. The S&P 500 was down 19.08% through the first two months of this year and then proceeded to drop an additional 7.86% in the first nine days of March bringing the total loss for the year to 26.94%. You will also fail to remember that the S&P 500 was probably the best performing asset class both domestically and internationally as most other asset classes were down much more. This was in addition to the losses incurred in 2008 when the S&P 500 dropped 37%. The S&P 500 then proceeded to bounce back 18.04% from March 10th through the 31st finishing the month up 8.76% and has been on an upward trend ever since. Fund flows did start to bounce back in April and May but the question becomes, were the people who sold out at the March lows part of the investors who were putting money to work again? I would think that most people who sold out at the lows sat on the sidelines for a good amount of time before putting any money to work again.

Dalbar Study

Dalbar recently concluded its 15th annual study of mutual fund investor behavior and the study once again has found that the average investor receives a fraction of index based returns due to buying and selling at inopportune times. To follow is a summary of the reports findings:

  • For the 20 years ended December 31st, 2008 the S&P 500 has returned 8.35% and on the fixed income side, the Barclays Aggregate Index earned 7.43%. Conversely, equity fund investors had average annual returns of 1.87% and fixed income fund investors 0.77%.[1]
  • The inflation rate averaged 2.89% over the same time period which means most investors failed to keep up with inflation due to poor market timing decisions.

Summary

Far too often the investor’s own behavior is the highest risk they face. Buying high and selling low is not the way to make money in the capital markets. Market timing seldom works, and the vast majority of people that attempt it do themselves great harm. Buy and hold may require some courage at times, but, it’s the only time-tested, proven way to reach your goals. Study after study has shown that the greatest detriment to long term investment results is often the person making the investment decisions.

Chart Data provided by Investment Company Institute ©. Weekly cash flows are estimates that are adjusted to represent industry tools, based on reporting covering 95% of industry assets. Monthly flows are actual numbers as reported in ICIs “trends in mutual fund investing”.

 


[1] Dalbar Study, Summary Analysis