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moneysense.ca, 18/02/10
Morningstar study on investor returns
Morningstar’s study on investor returns (hat tip to The Stingy Investor) confirms once again what other studies, such as DALBAR’s Quantitative Analysis of Investor Behavior, have consistently shown: investors are hurt by performance chasing and market timing. Morningstar found that U.S. investors, on average, earned 1.68% on their investments, the funds themselves returned 3.18% in the 2000-09 period. U.S. Equity Funds earned an average of 1.59% but the investors in those funds earned just 0.22% during the same time period. However, there are some surprises in the Morningstar study. Balanced fund investors (3.36%) experienced better returns than the funds themselves (2.74%) suggesting that investors in these funds are handling their emotions better. Interestingly, DALBAR also found that balanced fund investors held their funds significantly longer than both equity and bond fund investors.
You may also want to check out Morningstar’s explanation of dollar-weighted returns.
moneysense.ca, 18/02/10
There is probably segmentation hidden in this. There is a segment of performance chasers who have done significantly worse. There is a segment of disciplined investors who have done OK. The population of balanced fund holders includes only the disciplined investor segment, while the population of equity fund holders includes both.
@Houska: Yes. Absolutely. The disciplined buy-and-hold investors would have pretty much tracked the fund return over the different time frames (I’m simplifying a bit here) but among the performance chasers there would have been investors who did better than the fund returns and investors who also earned far less.
In another study of this sort, John Bogle found the same to be true of ETF investors.
Perhaps the fault isn’t with the methodology, but the lack of education and skill of those using the methodology. It’s like giving a set of tools to a kid… they may struggle to build something of value; however, given to an educated craftsman, they can be used to build something of significant value.
It seems that every study you quote is more evidence for the alleged superiority of your sleepy portfolio, in comparison to every other intelligent investment strategy. Just because the “average” investor’s performance was less than ideal, doesn’t mean that all intelligent non-index-investors are doomed to the same fate. You subscribe to a religion of mediocrity; not all of us do.
@Dale: And yet, you keep reading… In my book that counts as doing something right
I read your blog as part of my open-minded philosophy of continually being on the look-out for superior investing ideas. Much of what you write is good; however, you claim to help Canadians “prosper” while your sleepy portfolio has hardly kept up with inflation. In this regard I compare you to: Norm Rothery, Contra the Herd, and me.
A passive strategy is superior only in the sense that it will beat 70% to 90% of all active strategies that are out there simply by keeping costs down and sticking to a well-thought out plan. And the longer the time frame you look at, the lower the odds that an active strategy will beat a passive one. That doesn’t mean that *no* other strategy will or that guys like Warren Buffett are not out there; just that your odds of finding one are rather small. Bogle likes to call this “the relentless rules of humble arithmetic”. As a bonus, a passive strategy is easy to implement and follow.
The Sleepy Portfolio shows a return of 20% over 5 years. The CAGR is 3.59%. Last I checked that’s more than inflation. It is also neither here nor there. Short-term performance is meaningless. It’s the long-term that counts and there is no reason to change my opinion that a passive strategy will be superior over the long-term.
I’m suspicious also…
I’m waiting for that one day where we will see CC open an investment advisory company, and pitch nothing but low-fee, market-matching portfolios. – Wait a sec, sign me up!
More onto Dale’s point however, my problem is that the studies use averages.
I’ll wager the returns among the population does not follow a normal distribution, but is probably skewed to the right – so the majority of people are getting low returns, but many people, say 15-25% of the population are beating the averages by 1 or 2 standard deviations.
I agree with you all in the sense that most active investors will do worse than an index-only strategy. That said, I disagree that passivity should be preached to knowlegable investors when there are services such as: Rothery’s, Contra the Herd, and the October Strategy which have proven themselves superior to passivity. The Contra guys have been picking winners for a long time, and Rothery follows a long line of value investors who have been out-performing for a long time as well. One of the valuable functions that your blog could, but does not provide, would be to determine if there are other good strategies out there that would warrant consideration from non-average investors. Your 4% per year will not allow too many people to retire in the lifestyle to which they have become accustomed.
There will always be debate whether (or what does it take) to have distinctive alpha. The research says most active investors end up having negative alpha. Some do have positive alpha, the question is whether it is sustainable in the long term.
What’s often missed in this is the question of beta (market exposure). Some active strategies that appear significantly better than passive investing have positive relative return not through distinctive stock (or other investment vehicle) picking or timing, but since their active investment strategy effectively increases their market risk exposure (higher average beta of their holdings, perhaps via a not even deliberate choice of which market segments they overweight).
Not trying to pick on you Dale, but I quickly skimmed your website and I have no idea whether your impressive returns have been due to skill (alpha), luck (which may evaporate) or being more aggressive in your market exposure. Your use of the word “momentum” makes me fear the latter, though I may be wrong. How does your annualized volatility (based on daily, monthly, or weekly returns) compare to that of your benchmark? I’m not saying people should invest in your strategy with such short time frames, but that is a decent heuristic for whether your beta is significantly higher or not.
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Houska: mostly beta. My benchmark is that I attempt to better all reasonably diversified strategies at all times. When some other strategy bests me for 3 years, I will switch for the benefit of my own 7 figure portfolio.
A passive strategy is superior only in the sense that it will beat 70% to 90% of all active strategies that are out there simply by keeping costs down and sticking to a well-thought out plan. – Yeah, I agree on this one.
Some academic research on the topic: http://www.rhsmith.umd.edu/faculty/rwermers/ktww.pdf (from 2006). Does not address momentum strategies in particular, but the persistence and identifiability of alpha among investment managers.
Dale, again, not to pick on you, but the data I’m looking at do not support your strategy. Monthly returns in Canada for the TSX composite index in 2005-2009 were were no better or worse in October than in any other month. On the contrary, October was actually one of the best performing months if we look further back into the 1990s. Maybe I’m missing something here, but the idea of selling one’s entire portfolio in October and parking it temporarily in money market funds seems about as arbitrary a strategy as making bets on the market based on who wins the Super Bowl (which, by the way, some investors swear by – something to do with downmarkets when the AFC wins, who knows).
DM Your data is too short or not accurate ; a lot of studies validate going to cash in Sept/Oct. See some of the backrounders on my website. The reason for the autumn skittishness is investor psychology — all of the big crashes have happened in Oct and many investors sell or reduce in anticipation. 1929, 1987, 2000 and 2008 are the best examples.
Dale: I think asking why this blog doesn’t try to to promote particular active strategies to the general public is beside the point. Any strategy that works, whether it’s active trading based on rules or passive indexing, will fail when too many people do it. If enough people avoid stocks in October because it’s a bad month, the buy/sell activity around the start and end of the month will increase the performance in October. If 90% of investors index then they won’t be following anything but each other (does that make them momentum traders?) and it will be much easier to trade against them and make a profit.
The real point is that people need to consider the additional investment to successfully implement an active strategy (whether it’s research or selecting a good manager) against other options such as investing in themselves. After all it seems easier to profit by doing what really creates wealth on a macroeconomic level – people using their skills to create new things – rather than trying to get it from someone else.
For example last month I paid $1500 for a course that could well increase my monthly income by that much within 3-6 months (actually it may be close by the end of the month because I started to see things differently and made some changes this week). And last week I committed to something with an annual cost greater than the value of my investment portfolio (which I’ve been building for 3 years) – but it just might help me double my income this year and keep going up from there. The additional effort to get alpha just isn’t worth it to me. I don’t think you can even get close to 100% monthly returns unless you’re trading every single minute of the day. Most people won’t have as much flexibility in their income, but I think it’s a minority of people who can’t make relatively easy investments in themselves to improve their career.
Richard; By definition, momentum investing and autumn abstinence are likely to do better the more widespread the practices. Many of us are in, or nearing retirement, and can’t realistically get massive new gains out of our employment.
Houska; thanks for the reference to the Article concerning Star managers. Good, but a little on the dry side.
@Dale: I’m tired of arguing the same point over and over and over. It is clear that you are here trying to troll for new subscribers and you want me to do the job for you. I’ve expressed my opinion on your strategy in other threads: it is based on what could only generously be called “research”. We’ve been to the monkey bars in the post below and I have no appetite in having a playground brawl all over again.
http://www.canadiancapitalist.com/book-review-winning-the-losers-game/
I’m very comfortable with just getting beta. A passive strategy is a sound one and I have little interest in forever scouring for active strategies. It’s your game; I’m happy to watch from the sidelines and pass snide comments. In that spirit: all I can say is: knock yourself out and good luck to you and your subscribers.
I only post when you imply that all acive strategies are doomed to failure. When your blasphemy stops, so will I.
I challenge you to point me to a post that says that *all* active strategies are doomed to failure. What I do constantly harp on and stand by is the claim that a passive strategy will beat *most* active strategies simply by virtue of rock-bottom costs. It is silly to argue the first point because all you need to do to refute it is point to Warren Buffett.
In fact, this post isn’t even about active versus passive. It’s about fund returns (active funds, mind you) and investor returns and the gap between the two.
Both active investors and passive investors can benefit from sticking to a strategy (which I note you don’t appear to going by your comment of “when some other strategy bests me for 3 years, I will switch for the benefit of my own 7 figure portfolio”. So much for your conviction in the ‘October strategy’). As you are paying 2% or more in fund MERs and you don’t even have the conviction of sticking to your strategy (because all active strategies will inevitably hit patches of under performance), I think the odds of *you* beating the markets is rather slim.
“… investors are hurt by performance chasing” from this very thread implies that “All investors are hurt by performance chasing” in my opinion. Your blog is very popular; with popularity comes great educational responsabity. In my humble opinion, you could better excercise that responsability by being open to better and wider investor education of your readers. I would shut up if you would just educate them to be aware that there are active alternatives to the 4% solution for which you advocate. I am passionately comitted, not to my October Startegy –(should it underperform for three years)– but to participating in the best strategy I can find. If yours proves itself, I will be joining you. Let’s not get personal; I admire what you do here — I am merely exhorting you to do better.
CC Will a passive strategy beat 75-90% of all “active strategies” or “active/ willy nilly investors” who pay no attention to their portfolios and are part of the non-index camp?
@Dale: I implied nothing of the sort. “Investors” refers to “investors” as a group, exactly what the Morningstar (and DALBAR studies) are referring to. If I had wanted to say “all active investors are hurt by performance chasing”, that’s what I would have written.
It is my opinion that there is nothing particularly special about a momentum plus staying out of the markets in the Fall strategy. It is based on data snooping and if you look hard enough, you’ll find a lot of patterns in stock market data. If you find patterns that have worked in the past, word tends to get out and pretty soon market participants pile into it and make it disappear.
I make no distinction between “willy nilly investors”, “smart investors”, “stupid investors” or whatever. The fact remains that the vast majority of investing is done by institutional investors with deep pockets. These investors are definitely not “dumb” money and the reason they under perform is not because they are not smart. On the contrary, out performance is difficult because those competing are equally smart, equally driven and have equally deep pockets. I don’t think the odds of a part-time investor with access to the GlobeFund database are particularly good.
Is out-performance by Norm Rothery or Benj Gallendar equally unlikely?
As an aside, in theory the more people that pile into momentum and autumn abstinene, the better they are likely to work.
I certainly agree that a sleepy portfolio is the best if the investor does not have enough time to do adequate homework and the majority of people including myself cannot commit to it or do not have the time. I like Jim Cramer’s Buy and Do Homework strategy but again, I think this requires a lot more time than people are willing to spend.
I wonder how effective this ‘education’ (posts in the comments section of certain articles written by CC are).
If you look back through the wars, clearly those promoting active strategies are no more prevalent now after these wars than they were before – to me that’s a clear indication that someone’s altruistic education isn’t working.
I’ll challenge you Dale to show that CC’s conviction for passive investing strategies is actually detrimental to us reading the blog. Surely you do not believe that a passive strategy leads to negative results. If CC was proposing a losing (negative) strategy – then it would be proper to call him on it.
Not everyone can or wants to be Buffet. I know many people who’s investment philosophy is “Just as long as my $’s don’t decrease” – those solely in CD’s and bonds have actually done quite well over the past 10 year period.
I would also challenge you to ‘hone-up’ to your responsibility of helping us all become rich by improving your site and providing material that makes it as popular as CC’s.
CC’s has done a lot of good for Cdn investors. So much, that his popularity makes him the Oprah of the Cdn Personal Finance world. With that comes great resposibility. He now has investor/followers riding with him in his chosen vehicle, down his chosen road toward a common destination of financial independance. The leader of his followers has an obligation to look around once in awhile to consider: if his vehicle is still safe; if he is on the right road; and even whether the destination remains appropriate. I fear that CC has become closed to consideration of these questions, and that he is consumed by the rectitude of Bogle investing, and refuses to think outside of that box. He should be asking the big questions, and smaller ones that Bogle didn’t ask, such as: should investors have real estate in their portfolios, high yield bonds, REITs, Mortgage backed securities, etc. But, because Bogle didn’t sell these investments, CC’s followers cannot get the benefit of considering the merits of these types of investments, nor of any strategies of which Bogle and CC may have previously unaware. These are all dismissed summarily with platitudinous bromides such as the evidence is “data snooping”, or their “good results will get arbitraged away,” without any serious thought or analysis, other than “Bogle is our God, and therefore we must ignore all that he didn’t recommend (or sell)”.
[...] Morningstar study on investor returns – Canadian Capitalist [...]
@Dale: This is getting a bit ridiculous. You are a lawyer and should know better than suggesting something that can be easily disproved.
REITs, you say?
There are 9 posts categorized as REITs. I’ve also written others, especially about RioCan that don’t appear here:
http://www.canadiancapitalist.com/category/investing/reits/
I’ve even written about MBS back in 2007 (how did that work out for you?):
http://www.canadiancapitalist.com/invesing-in-ipos-mbs-and-emerging-markets/
I’ve even written about active investors, newsletters etc.:
http://www.canadiancapitalist.com/steadyhands-innovative-fee-structure/
http://www.canadiancapitalist.com/steadyhand-mutual-funds/
http://www.canadiancapitalist.com/cymbria-corporation-tsx-cyb/
http://www.canadiancapitalist.com/playing-devils-advocate-on-cymbria-cyb/
http://www.canadiancapitalist.com/the-investment-reporter/
http://www.canadiancapitalist.com/your-turn-checking-out-investment-ideas/
If you think that just because I honestly think that there is little substance to the “October strategy”, I’m being close-minded, so be it. The quality of research you base your investing on leaves a lot to be desired and your own website has little information besides “look at my returns over the past 8 years”.
Sure, you do say “in 8 out of 10 years, on average, the stock market (and equity mutual funds) goes down in September and/or October” but there are no numbers backing up your claim. Why is that? Why is there no explanation of why it would work in the future? It’s your job to make a better case for your strategy. You can’t expect others to do your homework for you.
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Dale, your reasoning that CC should help you promote your newsletter is ridiculous. all these claims about responsibility.
You are saying CC should help promote your silly strategy because he has a wide audience. That’s like saying Prime Minister Harper has a responsibility to argue for Communist views because he is influential.
I’m surprised at how patient you are CC. Kudos.
CC I have given up trying to convert you to anything other than open-mindedness. You never answered my questions about Norm Rothery or Benj Gallander, and I don’t think that the posts you cited refer to them, only Pat McKeough.
When I referred to mortgage backed securities, I meant MICs, and I now see that you shortly gave them the kiss off in one post because of the Ontario “sophisticated investor” requirement. In Western Canada we don’t have these requirements, and you might therefore reconsider them as an item of general interest. The ones in which I invest have paid 7 -12% for at least ten years, and would be safer than equities and many Corporate bonds. Have you ever considered actual hands-on Real Estate Rental Ownership? If you have, or will post on some or all of these topics and Benj Gallender, or Norm Rothery, you are indeed more open than I have assumed. Assuming so, I apologize.
As an aside, I do believe that one of the backgrounders on my site does discuss Cemil Otar’s “Seasonlity” back-testing for CDN Money Saver. He finds that Sept and Oct are to be avoided. See also Brooke Thackray’s “Time In/Time out”, which comes to a slighty different conclusion (mid Aust to Oct 27), and J Siegal’s Bible, Stocks for the Long Run. All “data-snoopers”.
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