Every year, Boston-based consulting firm Dalbar examines how average investors perform relative to what assets they own.
Every year, the study produces the same results; the average investor stinks at investing.
DALBAR's 22nd Annual Quantitative Analysis of Investor Behavior (QAIB)
You stink at investing
Dalbar has produced many different studies over the years.The studies vary in duration and asset classes considered, but the results are generally the same.
Specifically, Dalbar has found that since 1984, the average equity mutual fund investor has lagged the market by an average of 7.3% per annum. This poor performance is mainly due to attempted market timing by investors. Over the long term, mutual fund returns show a much better performance.
Average investor returns are even more astonishing when you include inflation. Inflation has averaged 2.6% over the past 30 years, which means that the average equity mutual fund investor's real return over the previous three decades is just 1.66%.
Fixed income mutual fund investors have had an even harder time.
Over the past three decades, the average investor has reaped a return of 0.59% per annum from fixed income mutual funds, compared to an average annual return of 6.73% on the Barclays Aggregate Bond Index.
Mutual fund bond investors have achieved an average annual real rate of return of -2.01%. For 2015, the average equity mutual fund investor underperformed the S&P 500 by a margin of 3.66%. The average fixed income mutual fund investor underperformed the Barclays Aggregate Bond Index by a margin of 3.66%. Meanwhile, in 2015, the 20-year annualized S&P return was 8.19% while the 20-year annualized return for the average equity mutual fund investor was only 4.67%, a gap of 3.52%.
The root of underperformance
It is easy to look at these figures and blame the poor performance on the mutual fund managers themselves, and there is some truth in this. According to the Financial Times, which cites research from index provider S&P Dow Jones, 99% of actively managed U.S. equity funds sold in Europe have failed to beat the S&P 500 over the past ten years, while only two in every 100 global equity funds have outperformed S&P Global 1200 since 2006. Almost 97% of emerging market funds have underperformed.
However, these figures are, to a degree, highly misleading. Actively managed mutual funds should not be designed to replicate an index’s performance. If they are closet indexing, investors should sell up and buy an index tracker, which is likely to achieve a more consistent return at a lower cost. It is the job of active mutual fund managers to produce a better return than the market over the long term.
In this case, better does not necessarily mean outperform; steady returns with lower drawdowns are the key objectives. What is more, compared to indexes, actively managed mutual funds are at an instant disadvantage.
Indexes do not account for the impact of taxes, trading costs and fees over time. Further, indexes benefit from survivorship bias, share buybacks and market cap valuation. All of these factors together mean that trying to consistently “beat” an index is an unachievable goal for most investors --but that is an argument for another day.
Conclusion
Whether you are an individual investor buying single stocks, mutual funds or index trackers, the Dalbar study contains some helpful and invaluable advice for successful long-term investing. Specifically, the researchers found there was one key reason why investors tend to underperform the index, which has nothing to do with the poor performance of active fund managers:
“No evidence has been found to link predictably poor investment recommendations to average investor underperformance. Analysis of the underperformance shows that investor behavior is the number one cause, with fees being the second leading cause.”
So there you go. Do not blame the active fund managers for your lack of performance over the years. The person you should be blaming is yourself for acting in a way that is incompatible with outperformance.
If you are looking for some tips on how to help you control your negative investing behavior, check out this article I wrote for GuruFocus on Investing Psychology.
Disclosure: The author does not own any stocks mentioned within this article.
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