Like Bill Murray’s character in Groundhog Day, it seems that average mutual fund investors are condemned to grossly underperforming the market year after year.
Indeed, in its soon to be released annual Quantitative Analysis of Investor Behavior (QAIB) report, Boston-based Dalbar has the unpleasant Phil Connors-style duty of reporting the same conclusion year after year — and this report, Dalbar’s 20th, offers a bracing conclusion:
“Attempts to correct irrational investor behavior through education have proved to be futile. The belief that investors will make prudent decisions after education and disclosure has been totally discredited. Instead of teaching, financial professional should look to implement practices that influence the investor’s focus and expectations in ways that lead to a more prudent investment decisions.”
Though 2014 marks QAIB’s 20th edition, Dalbar’s first report dates to 1984; as a result, Dalbar now has 30 years of data measuring the effects of investor decisions to buy, sell and switch into and out of mutual funds.
“The results consistently show that the average investor earns less — in many cases, much less — than mutual fund performance reports would suggest.
(The QAIB references index returns because of their wide acceptance, whereas equity fund returns can be calculated in very different ways, Dalbar informs ThinkAdvisor.)
So over the 30 years from QAIB’s inception to the 2013 market close — a period encompassing the crash of 1987 and subsequent market booms and busts — equity fund investors earned an average annual return of 3.69% compared with the S&P 500’s 11.11% return.
In last year’s robust equity markets, the average equity fund investor saw large gains — with average performance of 25.54% — but those results fell far below the S&P 500’s 32.41% return.
A “silver lining,” says Dalbar, is the improvement seen since the severe return-chasing behavior of the dot-com era:
“In 1999 the long-term annualized return of the equity market was 2.5 times that of the average equity mutual fund investor (18.01% vs. 7.23%).”
But whether then or now, the essential problem is that investors tend to sell after experiencing paper losses and return to investing after markets recover their value.
“The devastating result of this behavior is participation in the downside while being out of the market during the rise,” Dalbar says.
Given the persistence of this performance gap, this year’s edition of the Dalbar report focuses on ways that financial advisors can help investors avoid losing money through poor timing decisions.
“After enormous efforts by thousands of industry experts to educate millions of investors” that Dalbar says have been “ineffective,” the consulting firm recommends four key best practices for financial professionals: set expectations below market indexes, control exposure to risk, monitor risk tolerance, and present forecasts in terms of probabilities.
The first strategy derives from the idea that inappropriate investor actions stem from inappropriate expectations.
Since the market is a zero-sum game in which every trade’s winner is balanced by a loser, and furthermore since institutional market participants have advantages over retail investors, Dalbar asserts that “the average investor cannot be above average.”