If you were to pick one culprit to explain the dismal returns experienced by the average mutual fund investor, what would it be? While sales charges and high MERs typically shave off 2% to 3% and taxes take their own toll on returns, the worst culprit was identified by Benjamin Graham:

The investor’s chief problem — and even his worst enemy — is likely to be himself.

Our emotions are the biggest enemy of successful investing. We chase investments that have run up in value and dump our holdings at market bottoms. This destructive behaviour costs us dearly. According to a 2003 Dalbar Inc. study, the average equity investor earned 2.57% compared to 12.22% for the S&P 500 over a period of 19 years. Ironically, the average bond investor did better than the average equity investor earning 4.24% annually, slightly higher than the inflation rate of 3.14%.

Overcoming our negative impulses is a life-long process but investors can make a start by devising a suitable asset allocation and sticking to it. By staying invested through the market highs and lows, investors can get their share of whatever returns the markets provide without being handicapped by their emotions.

PS: If you haven’t done so already, do enter your name in the book giveaway. Contest closes tomorrow at 8 p.m.

This article has 16 comments

  1. While I don’t disagree with the main point of your post, I really have to question the Dalbar study that I keep seeing quoted on various blogs. From their website it appears that their main customers are brokers & advisor companies so they might be a bit biased. I recall reading that particular report a while ago and they really didn’t get into any specifics as to how they measured the various results which leads me to suspect the accuracy of their survey.


  2. Emotion > Discipline

    I have the opportunity to work with many investment advisors. They usually appear credible and their approaches sound. When you’re sitting in a meeting watch clients buy hot new flow through shares, for example, it’s so easy to be caught in the frenzy and place an order too. Now or never!

    I wait a day or two. By then, the excitement is gone.

    Inertia > Emotion

  3. Canadian Capitalist

    Mike: It’s not just the Dalbar study. John Bogle makes the same point about returns based on mutual fund inflows (investors see ads about recent returns and pile into a fund). I don’t have his book with me but will look it up this evening.

  4. Greed and Fears are definitely our worst enemy. It’s typical for several investors, they sell when they should buy and buy when they should sell. We would be better off entering our investment strategy into a computer and let it to the trading!

  5. I have often wondered if I would be better off not looking at my statements for months at an end. Its easier to stick to a plan if you are not focused on the short-term results a statement shows you.

  6. I love the CC but was surprised by the first few lines of this post and have to challenge it:

    The Dalbar message is about behavioural finance so it applies equally to “passive” low-cost index strategies (arguably more so). It is used here, however, as a post in part on why the dreaded mutual fund is oh so bad. Is that to suggest that behavioural finance only apply to mutual funds???

    I agree that the majority of investors have weak investment results because they are their own worst enemy; but I then counter that this has nothing to do with whether they hold mutual funds. It is investors (and advisors) emotions dealing with volatility. Indexes are often more volatile than active portfolios.

    Investors who choose to go the ETF route still have to deal with the same emotions, and arguably have to be somewhat more disciplined because they are usually doing it all themselves.

    Maybe I am interpreting this post wrong but to suggest – albeit indirectly – that index investors get a pass on being fallible human beings is something I have to stop and challenge.

    If anything, behavioural finance is the new academic trend that is overturning much of the traditional support for index investing such as the efficiency of markets, and rational decision making. That’s a whole other topic however and my point here is not to suggest that passive low-cost strategies are, in any way, “wrong”.

    I simply feel the message of the Dalbar study is that every investor – whether using stocks/bonds directly, ETFs, or mutual funds – should learn as much as they can about behavioural finance (the book ‘Beyond Greed and Fear’ is a good start) so they don’t suffer the same rate-of-return fate as the masses.

  7. Canadian Capitalist

    Hi Rob: Thanks for your comment. Re-reading the post, I don’t see that I implied that only mutual fund investors need to worry about overcoming their negative impulses and passive investors don’t. Even the offending first sentence should be read in the context that the Dalbar study looked into mutual fund returns and not those of direct holdings in stocks, bonds or T-bills.

    In fact, I wrote the post because I was recently asked “what is the one suggestion you would give to other investors” and I said without thinking “pay attention to costs”. But, while high costs (commissions for stock investors, fees for mutual fund investors) detract returns, the evidence shows that performance chasing is the biggest culprit for poor returns.

  8. I’d be interested in seeing a study done on Canadian investors (mutual fund or otherwise). In Canada I believe there is a higher percentage of investors who deal with an advisor compared to the US (not sure if this is still true or not) so it would be worthwhile to compare the results because if the Canadian investors did better it might be because of the steadying hand of their advisors. On the other hand if the Cdn results are similar or worse then it might show that the effect of advisors is negligible.


  9. Canadian Capitalist

    I have limited experience with financial advisors but I would say that most of the ones I’ve dealt with are simply “mutual fund salespeople”. They simply push a product (some “hot” funds) every year during RRSP season and collect the commissions and fees and I’d wager that the results won’t be much different from that of the Dalbar study.

    Many people have no interest in DIY investing. For them, I’d argue that they’d be better off paying the fees and hiring a competent advisor.

  10. CC – that is exactly my opinion too.


  11. Learning to tame your fear and greed is the first part of a good trading plan, unfortunately I have not yet learnt that;) That’s where passive, indexed portfolios are great.

    There are many fee only advisor’s who are often independent from any affiliations. They seem expensive up front but if they are actually unbiased (i.e., not pushing you into something they’d receive commissions for) it’d be worth it.

  12. “steadying hand of their advisors” – since when?

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  14. Thanks for the additional explanation CC – I understand your point better now.

    BTW – I would love to read your review of ‘Beyond Greed and Fear’ if you were so inclined.

  15. Canadian Capitalist

    Mike: Bogle notes that the average fund investor pays a penalty of 2.5% for chasing performance (compared to 1.5% for a passive investor).

    Bogle also quotes Warren Buffett’s “four E’s”: The greatest Enemies of the Equity Investor are Expenses and Emotions.

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