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Investors behaving badly

May 7th, 2009 · 15 Comments

Emotions continued to play havoc with investor returns in 2008. DALBAR’s update of its Quantitative Analysis of Investor Behavior (QAIB) study found that while the S&P 500 has returned 8.35% over a 20 year period ending in 2008, the average equity investor earned just 1.87%, which was less than the inflation rate of 2.89%. Bond investors fared no better. They earned returns of just 0.77% compared to 7.43% for the index.

The DALBAR update isn’t surprising. The QAIB has consistently shown a large gap between the returns investors actually earn and the return they could have easily earned with a buy-and-hold strategy.

Other studies have confirmed DALBAR’s findings. John Bogle in The Little Book of Commonsense Investing (read review here) calls it the grand illusion — the returns reported by mutual funds aren’t actually earned by fund investors. He estimates the over a 25 year period ending in 2005, the average mutual fund investor earned 7.3% compared to the 12.3% for the benchmark. The shortfall isn’t limited to active fund investors. Bogle also notes that index fund investors earned 10.8%, a full 1.5% shortfall compared to the index over the same 25 year period.

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15 responses so far ↓

  • 1 Sampson // May 7, 2009 at 9:35 am

    >>Bogle also notes that index fund investors earned 10.8%, a full 1.5% shortfall compared to the index over the same 25 year period.

    This is very surprising. Does he try to qualify why this might be? Fees and timing?

  • 2 Canadian Capitalist // May 7, 2009 at 10:51 am

    Sampson: It is timing. Passive investors are not immune to chasing performance (buying stocks after a run up) and either waiting for the dust to clear or pulling money out in a downturn.

    In fact, the about half the actual shortfall that Bogle observes for active funds are due to fees and the other half due to emotions. Index investors, of course, have nominal fees, so almost their entire shortfall is due to emotions.

  • 3 Sampson // May 7, 2009 at 11:42 am

    Thanks, and great review – this is actually a read I might be very interested in.

  • 4 Elbyron // May 7, 2009 at 12:53 pm

    This does sound very interesting. The sample chapter was entertaining as well. I don’t usually buy books, and my library has 5 copies of this book. They’re all checked out right now but I’ve got a hold on it and will be able to read it soon.

  • 5 investors behaving badly — award tour // May 7, 2009 at 1:07 pm

    [...] Investors behaving badly — Canadian Capitalist. “while the S&P 500 has returned 8.35% over a 20 year period ending in 2008, the average equity investor earned just 1.87%, which was less than the inflation rate of 2.89%. Bond investors fared no better. They earned returns of just 0.77% compared to 7.43% for the index.” Summary of a great report about average investors buying and selling at the worst times. [...]

  • 6 Alexandra // May 7, 2009 at 3:11 pm

    I think it is timing, too. My question is, though – how much of it is *investors* behaving badly, or investors acting on *bad advice*?

    I guess I’d need to figure out the proportion of people investing with an advisor or the proportion of dollars in managed (not self-directed) accounts in order to answer that. Hmmm.

  • 7 Dividend Growth Investor // May 7, 2009 at 4:47 pm

    I am also surprised that index investors could underperform the S&P 500 due to “timing”.
    I guess if you dollar cost average yor way into an index fund over the course of an year, you would underperform the index by year end in most years, especially since over 70% of the years the markets go up..

  • 8 Canadian Capitalist // May 7, 2009 at 5:04 pm

    @DGI: I think Bogle estimated the actual investor returns based on fund inflows and outflows. He does note that it is hard to estimate but my gut feeling is that it is correct. Investors do panic and pull money out in bear markets. They also may not be making regular investments and waiting for the dust to settle. Problem is when markets bounce back sharply, as we’ve recently seen (if March indeed was the bottom).

    @Alexandra: I tend to think of advisors as average investors as well, though they may disagree :) As a group, they chase performance and panic just like DIY investors.

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  • 11 Why do ETF Investors do worse than Index Mutual Fund Investors? | Canadian Capitalist // Jun 22, 2009 at 11:53 pm

    [...] June 22nd, 2009 · Jon Chevreau recently blogged (see John Bogle says investors getting killed by ETFs) on John Bogle’s analysis of returns experienced by investors in Exchange-Traded Funds (ETFs) and the results are not pretty: In 68 out of 79 ETFs, the returns experienced by investors lagged that of the ETFs themselves by an average of 4.5%. Bogle also found that investors in ETFs did much worse than investors in index mutual funds. In some categories such as large-cap stocks and small-cap stocks, the gap was particularly large — more than 7%. And the shortfall was as much as 12% in REITs! These results mirror that of the famed DALBAR study, which consistently finds mutual fund investors earning lower returns than the funds themselves (see Investors Behaving Badly). [...]

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    [...] a 10 year window with the end date being market bottom,  DALBAR’s analysis estimates that an average investor earned a paltry 1.87% a per annum. The poor results have been attributed to investors investing emotionally and buyin [...]

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