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The Average Investor's Returns
The Dalbar Study
Dalbar, Inc. is the leading market research firm for investment advisers. Recently Dalbar published the results of a twenty year study, in which they analyzed mutual fund cash flows to determine the average equity investor's returns.
According to this study, an investor who bought an S&P 500 index fund would have earned 11.9% annually for the twenty years from 1986 through 2005. The average equity investor, however, earned a 3.9% annual return.
John Bogle's Study
Shortly after the Dalbar study appeared, John Bogle, the founder of the Vanguard Group of mutual funds wrote of his own research in the Business section of the Sunday New York Times on October 15, 2006. Mr. Bogle's article "Why Your Fund Beat the Average, but You Didn't" reported his analysis of the 200 equity mutual funds with the largest money flows from 1996 through 2005.
Although the funds in the study reported average annual returns of 8.9%, the average investor in those funds earned only 2.4%.
Mr. Bogle attributed the underperformance to a variation of market timing in which investors pour money into recent "hot" funds. The fund managers are then unable to successfully invest the large cash inflows, the funds underperform, and then investors sell the funds at the bottom of their performance.
Schwab's Market Timing Call
The Chief Investment Officer of Charles Schwab, Liz Sonders, posted an article in the "Today's Market" pages of the Schwab website entitled "Exit: Underweight Equities, Neutral Bonds, Maximum Overweight Cash". In the article, Schwab's Investment Strategy Council recommended that investors underweight U.S. and international equities and continue to avoid emerging markets.
The article was posted on June 12, 2006. The U.S. and foreign equity markets had lost 6% and 12% respectively since May 9; people were anxious and hurt. Ms. Sonders' timing was almost perfectly incorrect: the equity markets bottomed out the following day. Since June 13 the S&P 500 has gained 13%, foreign equity markets have gained 17%, and emerging markets have gained 22%*.
Not surprisingly, this market timing article does not appear in Schwab's "Recent Commentary Article Library" even though articles written before and after June 13th are posted. The original article is here. Another article by Ms. Sonders dated October 13, 2006 recommends maintaining "slight underweight positions in equities". Presumably one would have to buy back the equity positions they sold per Schwab's recommendation on June 13th, at much higher prices.
We do not intend to single out Ms. Sonders as an example of ineptitude. We expect that Ms. Sonders is a very intelligent person who knows a great deal about money and investing, who sometimes correctly predicts market behavior. We bring this article to your attention for its simple beauty in illustrating the reason that most investors significantly underperform the markets.
Those of us who maintained our asset allocation through the downturn in May and June were amply rewarded. The rewards in investing are usually unexpected, but that doesn't make them any less sweet.
Some of the times Ms. Sonders and other market timers will make accurate calls. I just wonder how much the incorrect calls are costing her adherents.
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*June 13, 2006 through October 31, 2006
