Thursday, July 30, 2009

Recent Study on Investor Returns

The following is based upon a recent study on mutual fund investor performance by DALBAR's Quantitative Analysis of Investor Behavior (QAIB).

According to DALBAR, the S&P 500 returned 8.35% over the 20 years that ended in 2008 while, on average, equity fund investors earned just 1.87% (less than the inflation rate of 2.89%).

Beyond the performance of the actively managed equity mutual funds themselves, much of these poor returns come down to investor behavior. Buying the hot stock or mutual fund because it has been going up a lot recently and selling after the market has gone down out of panic or fear. That's a tough way to make money but studies have revealed how common this behavioral pattern is among investors. Many may think they can overcome this tendency but the prevailing evidence strongly suggests most do not. From the annual DALBAR study according to this press release and post:

"The dramatic events that continue to plague our financial markets have provoked panic, which exacerbates the ongoing carnage," said Lou Harvey, president of DALBAR. "For 15 years, QAIB has shown that investor returns lag what performance reports and prospectuses would lead one to believe is achievable. While those returns are, in fact, theoretically achievable, the reality is that investors are not rational, and make buy and sell decisions at the worst possible moments," he said.

That pattern wrecks long-term returns. It's a defect that needs to be unlearned and replaced with a more effective trained response. If good businesses are selling below intrinsic value, buy especially when it feels bad and the headlines are awful (and sell some holdings whenever you sense euphoria entering the equation and equities have become plainly expensive).*

"Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well." - Warren Buffett

Easier said but having the right temperament definitely matters.

Learning from this might help erase some of that 6.5% performance gap. It won't change the fact that too many professional managers underperform.

Still, investors would generally get improved results if they didn't chase performance and bought when the prevailing economic conditions are ugly and no one seems to want to own stocks.

Adam

* For many investors index funds make a lot of sense. The added risk and complexity of owning individual stocks works against long-term returns unless the investor truly understands business economics, consistently judges value well, and always buys with an appropriate margin of safety. The evidence supporting the idea that index funds are often the way to go is not insignificant. Yet whether buying individual marketable stocks or index funds it's important to not be buying what is popular at the moment. If it feels good to buy it's probably not cheap.

Related:
Investors behaving badly
You are Probably Bad at Investing
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