Besides needing to lose weight, floss, and pay more attention to our marriages lest we all end up divorced, it seems all of us need a shrink when it comes to investing, or at least the ability to call our “Life Line” for some correct answers. Why? Over the past 20 years investors in stock mutual funds have underperformed the S&P500 by 6.5% a year. (8.35% vs. 1.37%) Throw in inflation and the individual investor is under water for the past two decades!
And bond investing? Hoo boy, it seems we can’t get it right there either! Individual investors underperformed the Barclay’s Aggregate by 6.7% a year.
From the annual Dalbar study:
For the 20 years ended December 31, 2008, equity, fixed income and asset allocation fund investors had average annual returns of 1.87%, 0.77% and 1.67%, respectively. The inflation rate averaged 2.89% over that same time period. Equity fund investors lost 41.6% last year, compared with 37.7% for the S&P 500 Index.Bond fund investors lost 11.7% last year, versus a gain of 5.2% for the Barclays Aggregate Bond Index.
Dalbar, Quantitative Analysis of Investor Behavior (2009)
It’s not just that we under-perform in bull markets. We under-perform in just about every type of market. According to Dalbar this under-performance has been going on as far as they have been tracking it. That period includes part of the largest bull market in history and two of the worst bear markets. We apparently make buy and sell decisions at the very worst of times. We sell at bottoms when we panic and buy at tops when the euphoria of strongly rising prices has long set in. From an inflation adjusted perspective it’s not that we would have been far better off in T-Bills, we came close to the type of returns generated by “Under the Mattress and Can in the Backyard” approaches to investing. Apparently we need help and lots of it.
What should the individual investor's takeaway be from this information? An investor needs a plan! And the conviction to stick it out when emotions are running high. Buy and hold is such a plan, although I personally don't prefer it. If an investor's timeframe is long enough (and that is the key) buy and hold can produce returns that are adequate for most purposes and most investors. Asset allocation (done correctly) is a plan. Active trading methods(done correctly, i.e. with individual security values triggering buy/sell decisions) is a plan. But what is needed most of all is a plan coupled with discipline, especially of the emotional variety. Either that or get out of the markets altogether and invest money elsewhere. Markets are susceptible to all sorts of swings and most people fool themselves when they say they can accept the risk of losses that are inherent in the markets. And that is why they grossly underperform.
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