By Hutch Ashoo & Christopher Snyder
Several years ago Dalbar published a shocking study of investor behavior titled “Quantitative Analysis of Investor Behavior.” In 2005, Morningstar, the most widely followed mutual fund evaluation service, published its own study of investor behavior and how it affected investors’ rates of return.
What was so shocking about the Dalbar study?
Dalbar observed cash flows in and out of stock mutual funds and calculated the investors’ dollarweighted returns reflecting how well investors timed their purchases and sales. The study was performed from 1994-2002 and it included all U.S. stock mutual funds as a group.
During that time period, the S&P 500 averaged an annual rate of return of 12.2 percent; stock mutual funds averaged a 9.6 percent rate of return, while the average stock mutual fund investor netted a measly average annual return of 2.6 percent.
Dalbar concluded that investors were investing in the hot funds after their great years and cashing them out after they performed poorly (i.e., buying high and selling low). Has this ever happened to you either because of your decisions or your advisers’ advice? That’s right, investment advisers are just as guilty. This of course is the complete opposite of what smart investors should be doing, which is buy low and sell high.
Not much was made of the deviation in return between the average stock mutual fund return and that of the S&P 500 (i.e., the unmanaged S&P 500 outperformed the average stock fund by 2.6 percent).
As wealth managers, we would ask “why would anyone pay active money managers from Wall Street if, in many cases, they can’t beat the unmanaged stock market index?” (Read our white paper “Four factors the affluent must know to avoid financial disaster and secure their dreams” on our Web site.)
We hope you can see the daily conflict of interest occurring between Wall Street and your best interest (i.e., they are concluding and telling you what they want you to hear for selfish reasons). This is why we are always cynical of Wall Street’s hype of hedge funds and money management.
The major concern should be net rate of return, not Wall Street’s pocket book. Wall Street wants you nervous and in need of it. Just look at what they invest your money in! Does it seem self serving? Does it seem that after fees, commissions and expenses that they made more than you?
In 2005 Morningstar published a similar study of how investor behavior affected the returns you net. The study represented 10 years, ending April 30, 2005. Morningstar compared the official 10-year return of the average U.S. stock mutual funds in each category to the investors’ dollar-weighted return for that category.
The results were revealing and go a long way in supporting Dalbar’s results. Mutual fund investors in every category of U.S. stock mutual funds significantly underperformed (by an average of 2.68 percent) the stated category’s return. Morningstar attributed this dismal conclusion to poor decisions investors make when buying and selling their mutual funds (i.e., buying high and selling low).
There is never a time like the present to insure that you or your investment advisers are investing wisely. Read our twopart article appropriately titled “What should smart investors do?” (Sept. 14 and Oct. 12, 2007).
Authors Haitham “Hutch” Ashoo and Christopher Snyder are partners at Pillar Financial Services Inc. in Walnut Creek. Ashoo is founder, president and CEO. Reach them at 925-356-6780.