Investors finally getting it right: Dalbar

(April 13, 2005) In what is being hailed as a first, the average American equity mutual fund investor outperformed the overall S&P 500 in 2004, according to financial researcher Dalbar’s annual Quantitative Analysis of Investor Behaviour study.

“Average investors earned more in 2004 than the hypothetical buy & hold S&P 500 investor because inflows continued through the ups and downs of the 2004 market,” the report says. “The investments that were put in play during the down trending months catapulted into huge gains in the post-election boom.”

In the past, mutual fund investors have tried to follow the market with poor results, selling investments as the S&P 500 declined and buying as it rose. By adding to their positions in the down market, investors finally showed signs of understanding the basic “buy low, sell high” strategy.

Inflows still ebbed following market declines, though. For example, following the market decline of 1.6% in April, May’s inflows dropped to just $1 billion US, off $22 billion from the prior month. But the fact that the inflows remained positive is seen as a good sign.

Still, years of buying high and selling low have left their mark, with investor returns more than nine percentage points behind the S&P 500 over a 20-year period, the report says. “More recent behaviours show improvements where the difference fell to six points for a 10-year year period.”

One of the new measurements of investor behaviour added to this year’s study was the “Guess Right Ratio,” which tracked investor decisions in various market conditions. The study found investors are more likely to make the wrong choice in down markets, doing so 75% of the time.

To demonstrate the benefits of dollar cost averaging over frequent trading, Dalbar constructed hypothetical portfolios for each tactic, running from 1985 to 2004. The report says buying and selling funds resulted in the portfolio doubling its initial $10,000, while the dollar cost averaging portfolio ended the period with $35,000.

The study found that equity fund investors are holding onto their funds longer, with the average retention period now at four years. Asset allocation investors are holding onto their funds for five years, also a record. If these trends continue, the study says it could translate into “significant future gains for investors.”

Advisors are also playing an important role, Dalbar says, by encouraging discipline and protecting clients from behaviour that erodes investments. “While many investors can overcome these hurdles, most need the support of a financial advisor to supply the required discipline.”

A Canadian version of the study, comparing mutual fund investors to the performance of the TSX, is due out later this year.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com