Do investors behave badly? I’m not referring to institutional traders that risk billions, and in the view of some put entire markets at risk. I’m talking about individual investors, everyday people who primarily invest to ensure a comfortable retirement in the future. And by “bad”, I don’t mean with bad intent. I’m referring to behavior that runs counter to their best interests.
Let’s look at some data.
In January it was widely reported that the S&P 500 was basically flat for 2011. In other words, if you had invested $10,000 on January 1 of 2011, you would have had approximately $10,000 on December 31. As a dividend investing enthusiast, I know that isn’t exactly accurate, because the companies in the S&P 500 Index paid out an average of 2.12% in dividends in 2011, which means that investing in a fund that tracked the indexed should have left you $212 wealthier if you had invested $10,000. Regardless, the point remains that general stock market performance wasn’t great in 2011. Similarly, we often see funds touting their performance, and sometimes that performance looks pretty good, especially in mutual fund ads.
None of these numbers address the question that really matters, though: how did investors perform? These numbers are meaningless if they don’t translate to the wealth of investors actually increasing.
At no point in time have investors stayed in the markets long enough to enjoy the benefit of market returns.
Quantifying Investor Behavior
Luckily, since 1994, Dalbar has been analyzing investor behavior and publishing the results through the Quantitative Analysis of Investor Behavior, or QAIB. This is the kind of report that is not exactly eye-popping for most people, but pretty fascinating for advisor types. Of course, the fact that it’s boring does not undermine the significance of the findings.
- The average stock investor badly underperformed the markets in 2011. Including dividends, an investor in an S&P 500 index fund would have gained 2.12% before fees in 2011. At the same time, the average stock-based investor would have LOST 5.73%. The story is the same with bond investors. While the bond market performed well, as evidenced by the 7.84% increase in Barclays Aggregate Bond Index, bond-based investors gained just 1.34%.
- In case you’re wondering about investors who chose more diversified portfolios, “asset allocation” investors lost 1.27%, on average.
- On average, individual Investors are not effective at timing the markets. The 2011 study cites the example of September, which saw the biggest monthly gain of the year for the S&P 500. Investors didn’t do much during that month, and had actually pulled money out of the market in July and August. Fund flows increased after September. They hit a high for the year in December, just in time to lose half of the gains achieved in September. Incidentally, there is much data to support the argument that professional investors are ineffective at this as well, but that is a discussion for a different day.
- The average investor does not leave his/her money in place long enough for it to take advantage of expected returns. A quote from the report underscores the last point: “At no point in time have investors stayed in the markets long enough to enjoy the benefit of market returns.” We generally invest of the long term because a) that’s when we’ll need the money, and b) in general terms, history shows that we will be rewarded for doing so, even though short-term market disruptions can be severe. The Dalbar data suggests that many investors may get in for the long-term, but they trade out before they can enjoy the benefits of investing for the long term.
This isn’t a new phenomenon, and it surely won’t change anytime soon. Strictly speaking, this is an example of irrational behavior. To truly act rationally in this regard, however, requires the fortitude to counteract powerful emotions. This comes from extensive education, a healthy understanding of the history of markets, and a solid plan.