Dalbar Finds Chasing Returns Causes Investors To Stumble

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Eagerness to chase market returns continues to hurt mutual fund investors in their pocket books, says a new report from Dalbar Inc., a financial research firm in Boston.

Dalbar blames investors “fear and greed” for a self-destructive tendency to miss out on market upswings and sell too quickly on downturns. Failure to recognize the benefits of long-term investing is at the crux of the problem, Dalbar argues.

Average investor returns are at their lowest point since Dalbar began tracking this information in 1984, the company says.

It is no coincidence that the average length of time that investors retain a fund is also at its lowest point since 1988, the company believes.

“Most investors are unable to profitably time the market and are left with equity fund returns lower than inflation,” Dalbar concludes in its “Quantitative Analysis of Investor Behavior.”

Over the last 19 years, the average equity investor earned just 2.57% annually, the companys analysis finds. That is even less than inflation during that period, which amounted to 3.14%. And it is well below the 12.22% the S&P 500 index earned annually during those same 19 years.

The average fixed income investor actually did better than equity investors, although they earned a relatively paltry 4.24% annually over the 19 years, compared to the long-term government bond index gain of 11.7% annual gain in that period, Dalbar reports.

“As market returns rose, investors poured cash into funds in an attempt to capitalize on high returns,” the company explains in its report. “When the market swung low, investors scrambled to redeem their shares before they lost additional money. In fact, the average investor remained invested in equity or fixed income funds for less than three years, their decision to sell or buy motivated primarily by the swings in the market.”

In short, Dalbar notes, investors habitually buy high and sell low, and thus earn considerably less than the market indices.

“The market is the force driving the behavior to hold equity funds for a little over two years–shorter even than the average for fixed-income funds,” Dalbar observes.

The QAIB examined real investor returns from equity, fixed income and money market mutual funds from January 1984 through December 2002, analyzing data from the Investment Company Institute, Washington, and Ibbotson Associates, Chicago.

(ICI fund flow information includes data on institutional investors, which may not always closely reflect the behavior of individual investors.)

Dalbars newest study is similar to one it first did in 1994 of how mutual fund investors’ behavior affects their returns.

The finding that fixed-income investors held onto their investments an average of six months longer than did equity investors explains why they did better, Hopkins says. Sticking to their guns a little longer “made a big difference in investment results” for fixed-income clients, Hopkins says.

Hopkins notes, too, that trading volume typically hits a high point two to three weeks after each market peak. That only demonstrates that people are poor at timing their buying and selling, she says.

The results hold important lessons for financial advisors, she points out. Clearly, individual investors need professional guidance to keep them focused on the long term.

“Thats also when the financial advisor does well,” she says.

Its important for the advisor to present each financial product in terms of the objectives of the client, not on its past performance, she adds.

“That only leads them to attempt to chase performance,” says Hopkins.


Reproduced from National Underwriter Life & Health/Financial Services Edition, July 28, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.