Before going into the most recent update of the Dalbar QAIB study, it is probably worthwhile to provide some background on exactly how investor returns and fund returns can differ. I would bet that many just assume that investors always earn returns in line with those of the equity and bond mutual funds they hold, but this is definitely not always the case.
In a nutshell, fund returns represent what someone buying and holding a particular mutual fund would have earned over a specific time period. Returns for the “average investor,” on the other hand, factor in behavioral measures that can (and do) affect the actual returns earned by investors in these funds. Dalbar explains it this way:
“…the [QAIB] study utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. These behaviors are then used to simulate the ‘average investor.’ Based on this behavior, the analysis calculates ‘average investor return’ …”
In other words, switching among investments has an effect on the eventual return received, both on a long-term and short-term basis. Dalbar and others have found that investors who tend to hop from one hot mutual fund to another not only fail to enhance their performance over industry benchmarks, but have been shown to actually end up earning a far smaller return because of their periodic switching among funds.
Why do investors hop from fund to fund so much? The reasons vary, but my experience has been that some investors panic when losses occur and get out of the market. Others frequently change their investments to chase the hottest returns. Unfortunately, this hot performance mindset is aided by financial publications that routinely list the top five or 10 or 20 best funds for the previous year. Investors often look at their own return during the year compared with the “hot” funds, and decide to switch and get in on some of that high-powered performance.
Unfortunately, the mass migration of investors to funds with the best previous performance often guarantees that those funds will not repeat as a top performer the next year. The end result is that funds with hot performance one year often lag behind other funds in subsequent years. Thus, those investors who flocked into these funds after their best performance often find that they would have been better off had they stayed in their old funds.
So, do investors learn their lesson and look for funds with consistent long-term performance? The answer for many of them is “no,” and they continue hopping to the next hot fund and hoping for a repeat performance that seldom happens. This is what we like to call becoming a “Dalbar statistic.”
The 2009 QAIB Study Update
The 2009 update of the original QAIB Study measures performance over the 20-year period extending from January 1, 1989 through December 31, 2008. Considering that this period includes both the 2000 – 2002 and 2007 – 2008 bear markets, one might conclude that investors who frequently switch among mutual funds on their own might have had better results than those of the actual mutual funds, but you’d be wrong.
Here’s what the most recent update to the Dalbar QAIB Study found:
- Over the 20 years ending December 31, 2008, equity mutual fund investors had average annual returns of only +1.87% while the S&P 500 Index averaged +8. 35% over the same time period.
- Fixed income fund investors had average annual returns of +0.77% over the same 20-year period, while the benchmark Barclays Aggregate Bond Index averaged +7.43%.
- Note that both the equity and fixed income fund investors’ average returns were less than inflation, which clocked in at 2.89% over this 20-year period of time.
- Confirming the “lost decade” concept, Dalbar’s study showed that the S&P 500 Index had negative returns over 10, 5, 3 and 1-year time windows. Fixed income investors, however, fared better with the Barclay’s Aggregate Bond Index averaging positive returns ranging from +4.65% to +5.63% over this period of time. However, neither the average equity fund investor nor average bond fund investor beat the benchmark returns over any of the 1 to 10-year time windows.
-Gary D. Halbert, GDP, AdvisorLink, Halbert Wealth Management, QAIB Study, Dalbar
Knowing this information, and assuming that your employees and participants of your 401k plan are similar to the rest of the investor pool, what can you do as a plan sponsor to insure your employees don’t fall into this cycle of under-performance.
Seeking the help of a professional, who will take the time to work with each participant to create an investment strategy, is a critical step in truly helping your 401k participants succeed. It is very valuable to have someone alongside you to help make investment decisions, especially when the markets are volatile. Taking the emotions of fear and greed out of the investment process will most definitely help bridge the gap of performance that the typical investor has experienced.
To learn more about how a Registered Investment Advisor can help you and your employees make the most of their 401k, please contact us.