For the past 20 years, a research firm called Dalbar has been comparing mutual fund investors’ actual returns with the returns of the stock market. And for all of those 20 years, it has found that investors underperform the market. The key question is, “Why?”
According to Dalbar, it’s largely because investors are their own worst enemies. Instead of staying in the market, they move in and out, selling when declines become too steep to stomach any longer, and getting back in only after the market has already made up considerable ground.
The gap between the market and the typical fund investor used to be much greater. When Dalbar conducted its first study, it found a gap of over 10.5 percentage points between the market’s average annual return over the most recent 20-year period and that generated by the average fund investor’s portfolio. In its most recent study, that gap narrowed to just a little over 4 percentage points, an improvement it credits to “investor experience and education.”
Still, the company says such improvement has stalled in recent years, and it no longer believes education can bridge the gap: “It is now past the time for the investment community and its regulators to understand that the principle of educating uninterested investors about the complexities of investing is unproductive” (emphasis mine).
It went on to recommend a four-part approach “to relieve the decision making burden that has been put on investors.” Specifically,
- Replacing investor’s unrealistic expectations with, you guessed it, realistic expectations;
- “Controlling investor exposure to risk;”
- Monitoring investor risk tolerances; and
- Replacing the “mindless warning” that ‘past performance does not guarantee future results’ with probability-based market forecasts
All of which sounds a lot like education to me!
The Dalbar study has its share of critics. Harry Sit, for one, who blogs at The Finance Buff, believes the Dalbar study overstates the behavior gap. Some of the performance gap, he argues, can be explained by how the market performed during the period studied.
My two biggest take-aways from all this are:
First, whether the gap between the market’s performance and that generated by the average investor’s portfolio is 4 points or 10, and whether all of that gap or only a portion of it can be attributed to investor behavior, we investors are, in fact, often our own worst enemies. The more we decide on a trustworthy strategy that’s appropriate for our age and risk tolerance, and stay with it, the better off we will be.
Second, I couldn’t help but be disturbed by the phrase “uninterested investors.” Investing for future needs—whether funding our later years or helping our kids pay for college—is too important for people to decide they're not interested in the topic. The solution won’t be found in making decisions for people or forced wealth redistribution. Long-term, it’ll be found largely in providing age-appropriate, engaging, practical financial teaching starting as early as age two and continuing through college, and in fostering a culture of personal responsibility.
What are your thoughts on this?