We are all familiar with those childhood fables which remind us of good vs. evil, right vs. wrong, and in this case, a reality we may not want to face. In the fairy tale of Snow White, the Queen summons the magic mirror - asking; “Mirror, Mirror on the wall, who is the fairest of them all?” (The Queen, expecting the response that she is the fairest one, receives the truth). The mirror replies, “Snow White.” Yes - reality has just hit the Queen, it’s not her.
How is this fable comparable with the average equity investor? Let me explain. The average equity investor walks up to the mirror every year and asks; “Mirror, Mirror on the wall, who’s the best investor of them all (expecting a similar response as the Queen)? The mirror responds, “Not You – Again!” That mirror, called DALBAR, has just provided the truth about how the average equity investor has continued to underperform the overall market – as represented by the S&P 500 index. Reality has just hit them.
Let’s have the mirror explain why…
Since 1994, DALBAR's Quantitative Analysis of Investor Behavior (QAIB) has measured the effects of investor decisions to buy, sell and switch into and out of mutual funds over short and long-term time frames. The results consistently show that the average investor earns less – in many cases, much less – than mutual fund performance reports would suggest.
The 29th Annual QAIB report examines real investor returns from 1985 through the end of 2022, which encompasses the crash of 1987, bull markets of the 90’s, the drop at the turn of the millennium, the crash of 2008, recovery periods leading up to the most recent bull market, and the unprecedented events of 2020.
As the chart below illustrates, not only in 2022 did the average equity investor underperform the S&P 500 Index by a margin of 3.06%, but over the past 30 years the annualized S&P 500 return has been 9.65% while the 30-year annualized return of the average equity investor has been 6.81% - a gap of 2.84% per year.
The positive view from the chart shows that the average equity fund investor is slowly beginning to close the gap – especially over a 20-year period. In addition, when viewing just the calendar year of 2022, it was the smallest gap in over 10 years in every category (equity and fixed income).
Retention Rates
The primary cause for the consistent underperformance can be many factors but the end results can be determined by the average retention rate of each asset class. And how do we arrive at these retention rates? Let me give you a hint, Investor Behavior. The mirror explains that the primary cause is Short-Term Focus, as the chart below gives another clear vison. Over the past 23 years, the average investor has seldom managed to stay invested in their funds for more than 4 years.
Simply stated, what has happened to the average equity investor – by listening/reading/watching the “breaking-news” of the day – is the siren song of the financial media has fed investors 24/7 with the next potential “End-Of-The-World” event or crisis. In turn, investors’ thoughts trigger their emotions, their emotions define their behavior, and their behavior determines their investment performance.
As Author, Nick Murray has stated, “The Dominant Determinant of Long-Term, Real-Life Investment Returns is the Behavior of the Investor themselves.” Hence, the short-term focus of holding onto their equity funds for an average of only 4 years has now transformed the long-term investor into a short-term speculator or market prognosticator.
Which reminds me of the quote from legendary investor and author, Peter Lynch of the Fidelity Magellan Fund from 1977-1990. He stated, “Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than have been lost in the corrections themselves.”
Finally, you may recall last year was more challenging than most. If so, you are correct. Furthermore, how does it rate regarding the history of temporary drops in the market over time – or at least the last 50-Years? Let’s take a look. The last 50 years are displayed in ascending order of annual S&P return. The far left displays the worst year in the equity markets over the past 50 years (2008: -37.0%). The far right displays the best year in the equity markets in the last half century (1995: 37.6%).
According to DALBAR, “A year like 2022 is exceedingly rare. As…only 3 years out of the past 50 registered lower S&P returns than 2022. Only 11 years out of the past 50 have resulted in any losses at all. And while there have been only 6 years in which the S&P has lost double digit percentage points, there have been 9 years in which the S&P has advanced more than 30%.”
It may be difficult, but if you are still able to look into the mirror to ask one more question it would be this - how can I (investors) receive more of the returns that I’ve behaved myself out of? The Answer; when you have long-term investments based on a written financial plan, short-term events should be approached from a quote by another fabled character, Winnie-the-Pooh, “Never underestimate the value of doing nothing.”