DALBAR's 2012 report is just out
DALBAR is a quantitative research firm that uses data from the Investment Company Institute (ICI), Standard & Poor’s and Barclays Capital Index Products to compare mutual fund investor returns to an appropriate set of benchmarks. Covering the period from January 1, 1992, to December 31, 2011, the study utilizes mutual fund sales, redemptions and exchanges each month as the measure of investor behavior. These behaviors reflect the “average investor.” Based on this behavior, the analysis calculates the “average investor return” for various periods. These results are then compared to the returns of respective indices.
[Editor's note: Unfortunately, there is no Canadian equivalent to DALBAR, but to some degree there are similarities between Canadian and American investors and we could draw inferences from this U.S. report.]
There is very little empirical data on investor's actual real world performance, so a report from DALBAR is certainly an eye opener.
The question I would have to raise immediately is this: How can an average investor manage to underperform their own investments? If an investment produces a 5% return how can one manage to get less than a 1% return from the same investment? DALBAR says it is not the fault of the investment- after all, the investment has produced a 5% return but the investor has done something to destroy his own returns.
So very much unlike the media's penchant for blaming investment performance, we now have solid evidence that it’s not the fault of the investment - it is the fault of our human brain. Flawed creatures as we are, it is human behavior that appears to be the prime determinate of investment success. It is what we do with our investments after we bought them – is the key.
DALBAR findings:
That no matter the state of the mutual fund industry, boom or bust: Investment results are more dependent on investor behavior than on fund performance. Mutual fund investors who hold on to their investments are more successful than those who time the market.
The gross underperformance of the average investor in 2011 clearly displays what has been the case for over twenty-five years – irrational decisions lead to inferior returns. This is not just the case on a year-by-year basis, but for intermediate and long-term results as well.
Mutual Fund retention rates suggest that the average investor has not remained invested for long enough periods to derive the potential benefits of the investment markets.
Analysis of investor fund flows compared to market performance further supports the argument that investors are unsuccessful at timing the market.
Average equity mutual fund investors lost 5.73% in 2011 compared to the gain of 2.12% that simply holding the S&P 500[1] produced.
Both equity and fixed income[bond] mutual fund investors underperformed the market on a 1, 3, 5,10 and 20-year annualized basis.
The average fixed income mutual fund investor has not kept up with inflation on a 1, 5, 10 or 20 year annualized basis.
[1] the S&P500 is a broad based index of America's 500 largest companies
DALBAR claims that nine psychological factors are likely to be responsible for destroying investment returns and that they must be curbed to produce desirable results for investors:
1. Loss Aversion: Expecting to find high returns with low risk.
2. Narrow Framing: Making decisions without considering all implications.
3. Anchoring: Relating to the familiar experiences, even when inappropriate.
4. Mental Accounting: Taking undue risk in one area and avoiding rational risk in others
5. Diversification: Seeking to reduce risk, but simply using different sources.
6. Herding: Copying the behavior of others even in the face of unfavorable outcomes.
7. Regret: Treating errors of commission more seriously than errors of omission.
8. Media Response: Tendency to react to news without reasonable examination.
9. Optimism: Belief that good things happen to me and bad things happen to others.
Source: DALBAR, Quantitative Analysis of Investor Behavior (QAIB) April 2012 www.dalbar.com www.qaib.com
