Well, how do I say this? Individuals, as a group of investors, are the worst class of investor that exist. Sorry. I would certainly like to ’sugar coat’ this topic with sprinkles but the multi-decade long studies of Investor Behavior created by DALBAR has the data in my favor allowing me to make such a statement.
Dalbar creates what is called the Quantitative Analysis of Investor Behavior (QAIB) study. They have been doing this report for many years. Simply put, over multi-decade time frames, typically two-decade time periods, the investment returns for the individual investor are dismal at best.
Over twenty years, the individual investor cannot keep pace, or even outperform, inflation. The graph below reflects the past twenty years ending in 2009. The average return for investors in stock mutual funds was 2.3%! Inflation outpaced the individual investor at 2.8%. Investors constantly ‘obsess’ with the idea of outperforming the market. The market (as measured by the S&P 500 Index) has returned 8.2% annually over the past twenty years. Individual investors cannot come close. So this ongoing conversation about finding investments that outperform the market, how about just getting to the market returns before worrying about beating them?
(Above Graph disclosures: The indexes used are as follows: REITS: NAREIT Equity REIT Index, EAFE: MSCI EAFE, Oil: WTI Index, Bonds: Barclays Capital U.S. Aggregate Index, Homes: median sales price of existing single-family homes, Gold: USD/troy oz, Inflation: CPI. Average asset allocation investor return is based on an analysis by Dalbar Inc. which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. All returns are annualized (and total return where applicable) and represent the 20-year period ending 12/31/09 to match Dalbar’s most recent analysis.)
Another way to look at this topic is in the flow of money into, and out of, mutual funds. Again, the story is one of emotion. Buy at the top, and sell at the bottom. My four minute video on YouTube titled Investor Emotions would be a good primer for the reader, and how I have created a process to greatly reduce, hopefully eliminate, investor emotion.
As we all now know, 2009 was one the most explosive stock market rallies in recent history; second only to returns generated in the 1930s. Everyone ‘caught’ this 2008-2009 rally right? Everyone ’stayed the course’ or even purchased more stocks for this once in a lifetime stock market rally? Right? Well no, ‘NOT EXACTLY’ as the quote goes. Look at the 2009 ‘flow of funds’ for mutual funds. It tells a much different story.
A record $306 billion went into taxable bond funds while investors withdrew net -$9 billion from equity mutual funds. Interest rates are at historic lows, and as we know, bond values have an inverse relationship to those of interest rates. Over time, rates will go up, and when interest rates do go up, bonds will lose value. So not only did the individual investor miss the greatest stock market rally in their adult lives during 2008-2009 when they sold stocks, they bought bonds at the top of the bond market as well.
Investors need to sell greed and buy fear, not the opposite.
Mutual Fund Flows. Note the poor investment choices individual investors made in 2009. Nothing has changed with respect to investor behavior, investor emotions; buy high, sell low. Investors sold stocks (at the bottom) in 2008 and 2009 and purchased bonds (at the top) in 2009 as illustrated below.
The graph below, from Bessemer Trust, reflects investor buying ‘habits’ ten years apart. Stock purchases at the market tops beginning in 1999 and bond purchases at the market tops beginning in 2009. Ten year differential, different asset classes, same result, buying asset classes at the high.
The slide below also reflects how individual investor returns pale when compared to institutional investor returns such as those for foundations, endowments and corporate and public pension plans. Why is this you ask? Simple, institutions have an investment process for investing their funds; they do not use emotion. Process works, emotion does not. Let me reiterate, “My four minute video on YouTube titled Investor Emotions would be a good primer for the reader, and how I have created a process to greatly reduce, hopefully eliminate, investor emotion.”
(Admittedly, the chart above is dated, but investment process, over emotion, is what creates the performance differential-that’s the take-away in the chart above)
“The idea that a bell rings to signal when investors should get into or out of the stock market is simply not credible. After nearly fifty years in this business, I do not know of anybody who has done it (time the market) successfully and consistently. I don’t even know anybody who knows anybody who has done it successfully and consistently”
- John Bogle, founder of Vanguard Investments (source here)
There are two types of returns
Due to the behavior of individual investors, buying high, selling low, there are actually two types of returns, “Investment Return” and “Investor Return“. Investment return is the actual return of the investment on a calendar year basis; say that of any mutual fund from January 1st to December 31st as measured by the change in the ‘net asset value’ (NAV) of the fund. Then there are the investor returns, based upon the individual’s personal purchase dates and sale dates (cash flows); Again, it is usually that of buying high, selling low as we just read in the above 2009 flow of funds information.
The difference between these two returns is called the “Behavior Gap”. A good financial advisor worth his/her salt knows this and manages around it. OK? Someday I should print new business cards with the title, “Behavior Modification Specialist”, and you laugh…… 
Chart Source: http://www.behaviorgap.com
Conclusion; Retiring with Dignity, can it still Happen?
If you, the reader, are an employer you may be asking yourself, what liability do I have for my employees within our 401(k) plan based upon these investment results and these investor behaviors? Well, 55% of all mutual fund assets (as of 2009) were held inside qualified retirement plans, so yes this data does affect you, your employees and your fiduciary responsibilities as a plan sponsor. You may wish to read about my philosophy on the state of the 401(k) plan arena below.
http://www.davidgratke.com/401K.html
David Gratke Wealth Advisors, LLC (DGWA) recognizes there are fundamental flaws within the traditional 401(k) retirement plan. When 401(k)’s started in 1978 when Congress amended the IRS code, this would change retirement plans unlike before. Prior to 1978, retirement (pension) plans were principally managed by professional investment managers. The 401(k) did just the opposite; it required participants to direct their own investment decisions, thus creating what might be called the ‘accidental investor’. For the most part, the accidental investor does not want the task, duty or responsibility of directing his or her own investments decisions. They are ill equipped as investor behavior studies bear this out. As a result, we at DGWA believe the traditional ‘do-it-yourself’ 401(k) plan is fundamentally flawed in three ways.
- Plan Underperformance
- Personal Liability for Sponsors
- Complicated Administrative Burden
DGWA has teamed up with other innovative industry professionals to deliver solutions, which once implemented, lead to improved plan performance, reduction of sponsor liability and a simplified process overall. Let us review your plan with look at plan performance, plan costs, success of your employee education program and lastly, your fiduciary liability. From there, let us offer a strong recommendation where needed in order to redirect your plan’s resources in a more purposeful, productive fashion.
Contact David Gratke now to review your 401(k) plan
Thank you for reading.
