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 back, “Snow White.” Yes…reality has just hit the Queen, it’s not her.
How is this fable analogous 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. These effects are measured from the perspective of the investor and do not represent the performance of the investments themselves. The results consistently show that the average investor earns less – in many cases, much less – than mutual fund performance reports would suggest.
The 28th Annual QAIB report examines real investor returns from 1985 through the end of 2021, which encompasses the crash of 1987, bull market 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 2021 did the average equity investor underperform the S&P 500 Index by a margin of 10.32%, but over the past 30 years the annualized S&P 500 return has been 10.65% while the 30-year annualized return of the average equity investor has been 7.13% - a gap of 3.52% per year.
Source: “Quantitative Analysis of Investor Behavior, 2022,” DALBAR, Inc. www.dalbar.com
Now, before you run to the computer/phone to sell your investments and buy the S&P 500 index, the mirror reveals the causes - if you read the title of the survey. Let me give you a hint, Investor Behavior. The mirror explains that the primary causes are Short-Term Focus and Market Timing, as the chart below gives another clear vison. Over the past 22 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 is – by listening/reading/watching the “breaking-news” of the day -- 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.
In analyzing the holding period of the average equity investor, the next question you may have for the mirror is - “has my (investor’s) market timing been successful? According to DALBAR, investors have “guessed right” 11 of the past 20 years (chart below) but guessed correctly only 4 of the 12 months in 2021. The reason, according to DALBAR, is that despite “guessing right” 55% of the time over the past 20 years, “…the Average Investor, whether they guess right or wrong, it seldom produces superior gains either way because the dollar volume of bad guesses exceeds the dollar volume of right guesses. Even one month of wrong guesses can wipe out several months of right ones.” Said another way, when you missed - you missed really big.
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.”
It may be difficult, but if you are still able to look into the mirror to ask one more question - 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.”
Disclosures:Advisory services are offered through Melone Private Wealth, LLC (“Melone Private Wealth”). Advisory services are only offered to clients or prospective clients where Melone Private Wealth and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at https://www.meloneprivatewealth.com/.
The information provided is illustrative, for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
Equity benchmark performance and systematic equity investing examples are represented by the Standard & Poor’s 500 Composite Index, an unmanaged index of 500 common stocks generally considered representative of the U.S. stock market. Indexes do not take into account the fees and expenses associated with investing, and individuals cannot invest directly in any index. Past performance cannot guarantee future results.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.
Average stock investor performance results are based on a DALBAR study, “Quantitative Analysis of Investor Behavior (QAIB), 2022.” DALBAR is an independent financial research firm. Using monthly fund data supplied by the Investment Company Institute, QAIB calculates investor returns as the change in assets after excluding sales, redemptions and exchanges. This method of calculation captures realized and unrealized capital gains, dividends, interest, trading costs, sales charges, fees, expenses and any other costs. After calculating investor returns in dollar terms, two percentages are calculated for the period examined: Total investor return rate and annualized investor return rate. Total return rate is determined by calculating the investor return dollars as a percentage of the net of the sales, redemptions, and exchanges for the period.
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