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By Arin Ruttenburg*
To achieve great investment results as opposed to acceptable it is critical to understand what long term means. So many investors, especially in recent times, are treating long term investing as up to five years because of market noise, resulting in switching in and out of funds instead of remaining invested for at least seven years or longer. This happens particularly with retirement investments, with bad results.
Since 1994, Dalbar’s Quantitative Analysis of Investor Behavior has measured the effects of investor decisions to buy, sell and switch into and out of mutual funds (the international term for unit trusts) over short and long-term timeframes. The results consistently show that the average investor earns less – in many cases well below – what mutual fund performance reports would suggest.
The report constantly examines real investor returns in equity, fixed income and asset allocation funds, which are funds that have a blend of equity, bonds, property and cash. The analysis covers a 30-year period, encompassing the crash of 1987, the drop at the turn of the millennium, the 2008 financial crisis, plus recovery periods of 2009, 2010 and 2012 and examines the results of investor behavior on the average investor and poses the question as to whether an investor’s “best interest” should include investor behavior.
Key findings of Dalbar reports of the past 20 years:
- In 2016, the average equity mutual fund investor underperformed the S&P 500 by a margin of 3.66%. In other words , had an investor remained invested as opposed to switching in and out of equity funds, or chasing the best performing equity fund, this statistic would be different today with upside for the mutual fund.
- In 2016, the average fixed income mutual fund investor underperformed the Barclays Aggregate Bond Index by a margin of 3.66%.
- Equity fund retention rates (the time an investor holds on to their equity fund) which is typically associated with long term investing decreased slightly in 2016 from 4.19 years to 4.10 years. Nowhere near seven years!
- In 2016, the 20-year annualized S&P return was approximately 8.19% while the 20-year annualized return for the average equity mutual fund investor was only 4.67%, a gap of 3.52%.
- Money Market assets, as a percentage of all mutual fund assets, tend to increase substantially during periods of market downturn but is only reinvested into the market slowly during market recoveries.
- Investors seem to chase the best performing funds, which may not end up being a great strategy as this year’s best funds can also be next year’s worst funds.
- No evidence has been found to link predictably poor investment recommendations to average investor underperformance. Analysis of the underperformance shows that investor behaviour is the number one cause, with fees being the second leading cause.
The role of a financial planner
Just as professional athletes can accredit some of their performance to their coaches, it is ultimately the professional who executes the movement. The same goes for the financial planner advising an investor, but it is the investor who ultimately builds wealth!
Over and over, it emerged in Dalbar’s report that the leading cause of the diminished return investors experience is their own behavior. No evidence was found that poor investment recommendations were a material factor.
Analysis of underperformance shows the following are the primary causes over the last 20 years.
- Lack of availability of cash represents the investor return that is lost by delaying the investment.
- Need for cash represents the percentage of investor return that is lost or gained by withdrawing the investment before the end of the period being measured.
- Voluntary investor behavior generally represents panic selling, excessively exuberant buying and attempts at market timing.
Key finding to note from the report is this: “No matter what 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 have been more successful than those who try to time the market.”
Similar to a coach guiding an athlete to be on top of his/her game, so should a financial advisor be a coach making sure investors stick with the plan; that portfolios selected are in line with the investor’s goals and objectives; provide guidance when the market is falling and making sure changes to a portfolio are made when appropriate.
My golf coach once told me that the most important club in my bag is between my ears. Not that it made me a pro golfer, but the message was clear. What separates the good from the great is the ability to stick to the advice of their coach and remain committed to their goal.
- Arin Ruttenburg is a Junior Financial Planner at Brenthurst Wealth.