According to Wikipedia, the definition of Pathology is the study of the causes and effects of disease or injury. And based on this definition, one may ask – why would one say that a fixed income investor has a disease? My interest, for this essay, is in the determination of the process or the causes of the Fixed Income investor’s mindset. Simply stated – I ask, why would they do that?
Let me step back a moment – I completely understand the asset class of fixed income (bonds) as a normal, natural component of asset allocation. No issues here. Understanding that bonds have been keeping up with the cost of living - historically speaking - as the real return (after inflation) has been about 3% since 1802*. However, what motivates one to place one hundred percent (100%) of one’s long-term portfolio into an asset class that historically has barely kept up with inflation?
Now comes the Pathology – the return mentioned above has been the index return. The actual return for the average fixed income investor, in the real-world with real emotions, has been 0.34% return over the last 30 years. Hold on for a moment - it gets worse. And what, you may ask, has inflation been over said 30 years? Roughly 3.38% per year as of 12/31/2021. Some quick math brings me to a real return (net of inflation) for the average fixed income investor of – wait for it – negative 3.04% per year for the last 30 years. Hence, the pathology.
Where was I able to find what return the average fixed income investor has received over this period? Dalbar, Inc. According to Dalbar, not only has the average fixed income investor underperformed its index (5.29% per year) but they have not kept up with inflation at 3.38% per year. Just so you do not think I have been “selective” in my time periods to make it look bad – the average fixed income investor has also underperformed inflation over the last 1, 3, 5, 10 and 20 years. Again – the pathology.
To keep this essay somewhat brief (as most are likely becoming tired of reading) - the primary cause, in my opinion, is Human Nature. More to the point, an inherent fear of the future which was already entrenched into the mind of the fixed income investor. Then sprinkle on the effect of negative real returns versus inflation – and there you have the pathology.
If you are interested in learning more about the full process, I have written about The Anatomy of an Investor Returns here.
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Bond, Average Fixed Income Investor and Inflation over 30 years - Source: “Quantitative Analysis of Investor Behavior, 2021” Dalbar, Inc. www.dalbar.com