By: Frank Armstrong
By: Frank Armstrong, CFP, AIF
The results are in, and they stink! Dalbar’s 2003 update of their widely quoted study, “Quantitative Analysis of Investor Behavior” (QAIB) shows investor behavior and achieved results spiraling downward in tight formation.
Investor results for the average American investor have almost nothing to do with market returns, and everything to do with their own behavior.
By tracking aggregate cash flows into and out of mutual funds on a monthly basis, Dalbar documents achieved performance for the entire group of investors. They identify market timing, chasing yesterday’s hot performers, and reduced hold time for long term investments as the chief culprits.
As a point of reference, achieving enviable results during the study period of 1984 through 2002 would have been childishly simple. For instance, domestic equity fund investors could have pursued the naÃ¯ve strategy of buying and holding the S&P 500 index. Simple, economical, effective. It would have returned 12.22% annually. The dumbest investor on the planet could easily have obtained that result.
Yet, by attempting to improve on that naÃ¯ve strategy, investors managed to destroy themselves economically, proving once again that their own behavior is the biggest risk that they face. The average equity fund investor managed to earn a dismal 2.57% during the covered period. This was significantly worse than the inflation rate of 3.14%. But, it gets worse: Those results are before taxes, commissions, fees, and transaction costs. The bottom line for these investors was a real net loss over 19 years that included one of the best bull markets in history and generated above average returns for the entire period. There is no way to characterize this outcome other than a massive failure and economic calamity for investors. On an after tax, after transaction cost basis, investors would have been better served to hide their money under the mattress.
Cash flows follow market performance in an all too predictable vicious cycle: Market declines – time lag – investors sell. Market recovers – time lag – investors buy. Repeat until financial failure.
When money moves within the mutual fund universe, the flows are from an asset class that recently under-performed to one with high recent performance. Buy high, sell low and wonder why you aren’t making money in the world’s capital markets is a sure fire formula for disaster.
Equity mutual funds are long term investments. The longer you hold them, the better the expected performance. Yet, Dalbar finds that the average hold time for equity funds is steadily decreasing. Today, the hold time is a short 29.5 months.
The link between investor behavior and achieved performance is crystal clear. But, investors appear to be constitutionally unable to connect the dots that associate their actions with their results. Something else is crystal clear. Investors can’t afford to continue their mistakes. Market timing, performance chasing, and rapid turnover are proven losing tactics. Investors must educate themselves, draft a strategic long term plan that meets their needs, execute it with discipline, and resist falling back into their evil ways. If they can’t or won’t do that, they need to hire someone that can.