| May 07, 2015
This month we take a look at the 21st annual Dalbar report, a large ongoing study measuring the effects of reacting to short-term market fluctuations and outlier events. Bottom line: when we behave emotionally and not rationally with our investments, the consequences can be surprisingly negative. We’ll show you the painful truth. But first, a look at April results.
Large-cap U.S. equities ended April on a positive note with the S&P 500 returning 1%. The S&P Mid- and Small-Cap U.S. equities did not fare so well, ending April down 1% and 2%, respectively.
Outside the U.S., both developed and emerging markets had a notable month, gaining 5% and 8%, respectively, aided by a decline in the U.S. dollar. U.S. Real Estate Securities slid 6%. In contrast, REIT indices outside the US returned 2.5%.
Most fixed income indices declined as yields ticked up. The S&P U.S. Aggregate Bond Index declined slightly, while the 10 Year U.S. Treasury bond index declined 1%. Commodities enjoyed a strong month, fueled primarily by the Energy sector. The Dow Jones Commodity Index and the S&P GSCI gained 6% and 11%, respectively.
EMOTIONS HAVE NO PLACE IN INVESTING
Rationally, we understand investing is a long-term process. Emotionally, we behave otherwise. This means we are sometimes our own worst enemy when it comes to investing for the long-term.
Since 1994, DALBAR’s Quantitative Analysis of Investor Behavior (QAIB) has measured the effects of investor decisions to buy, sell and switch into and out of mutual funds over short and long-term timeframes. Results consistently show that the average investor earns less—in many cases, much less—than mutual fund performance reports suggest.
For example, despite a wobbly start in 2014 and a plunge in October, the S&P 500 returned 13.69% last year. Achieving that return required a level of patience that eluded many investors. According to the Dalbar study, the average U.S. equity mutual fund investor underperformed the S&P 500 in 2014 by a wide margin of -8.19%. This was not an anomalous result. Over the last 30 years, the S&P 500 has managed an annualized return of 11.6%. But over the same period the average mutual fund investor has managed a return of just 3.79%.
The numbers look even worse in periods of market turmoil or uncertainty. The worst monthly underperformance over the past three decades was during the Lehman meltdown in October 2008, when the S&P 500 dropped 16.8%. Fearing mounting losses, many investors bailed out before a month-end rally, locking in an average loss of 24.2% and underperforming the benchmark by 7.4% for the year.
What’s the lesson? That in good times or bad, investors who stay the course do far better than those who are swayed by their emotions (particularly fear and greed). Our emotions are easily stirred up by misleading scare stories peddled by pundits, interest groups and influential economists retained by the financial services industry. Ignore them all.
Here’s another pitfall: looking through the rear-view mirror at last year’s returns. Do you find yourself latching on to a distinct data point or specific index return and bemoaning your performance? Perhaps it’s a YTD or QTD number. We call this “frame of reference risk.” The wrong frame of reference—fixating on what happened last year or what’s happening right now—can be very damaging if you act on it. Right now the leader is Emerging Markets. Who expected that? How long will it last? Should you pour money into that sector?
You know our answer. Fend off the risk of irrational behavior by adopting a long term vision, employing a buy-and-hold strategy carefully rooted in your own goals, risk tolerance and time horizon, and by not reacting to short-term market conditions. The Dalbar report shows that when investors react to the market or misleading analogies, they generally make the wrong decision. We couldn’t agree more.