Just about every sports fan knows the joy of rooting for your favorite team when things are going well, when the wins pile up. But the opposite can also be true – in those years when your team is “rebuilding” (which is really a euphemism for losing all the time), it’s easy to jump ship and wait it out elsewhere.
If you think sports fans are fickle or “fair weather,” investors arguably take it to an entirely new level. The research firm DALBAR tracked how often investors “switch teams,” or how often they move from mutual fund to mutual fund and/or strategy to strategy. They collected some fascinating data in the research process, and we’ll dig into their findings below.
How Short-Term Investments Translate to Underperformance
Investors may switch strategies for a multitude of reasons: the manager was/is underperforming, something ‘better’ comes along, the investor reads something in the news that causes them to rethink their approach, and so on down the line. DALBAR lists a slew of psychological, “behavioral finance” type attributes that cause investors to shift strategy so often: loss aversion, following the herd, regret, etc.1 You get the picture.
Based on a 20-year analysis from 1996 – 2015, the research showed that equity mutual fund investors and fixed income mutual fund investors, on average, did not manage to stay invested in their funds for more than 4 years. Considering that many investors have goals and objectives that span 20+ years, this is arguably an issue.
There are a lot of reasons ‘short-term investing’ is not a great idea for a person with long-term goals. But one of the main problems cited by DALBAR is underperformance. In 2015, the 20-year annualized return for the average equity mutual fund investor was 4.67%, while the S&P 500 annualized return over the same period was 8.19%, a gap of 3.52% per year. In dollar terms, that can mean a significant opportunity cost for investors, if one considers the power of compound interest.
One of DALBAR’s key findings and assessments drives the point home: “over and over, it emerged that the leading cause of the diminished return is the investors’ own behavior. No evidence was found that predictably poor investment recommendations were a material factor.”
According to DALBAR, a common theme among negative behaviors is that they often lead investors to unnecessarily abandon a sound investment strategy that was designed in accordance with their goals, risk tolerance and time horizon. They go on to say that the best way to ward off these negative behaviors is to commit to a strategy (probably for more than 4 years!) that focuses on one’s goals and is not focused on short-term investment gains or short-term market conditions. The question investors and readers should ask is: are you switching strategies too often, and has doing so affected your overall performance?
Partnering with WrapManager Can Turn Short-Term Investing into Long-Term Strategy
The data from DALBAR’s research shows that the average equity and fixed income mutual fund investor has not stayed invested for long enough to reap the rewards that the market can offer for more patient and disciplined investors. The data also shows that when investors react, their behavior can lead to diminished returns.
At WrapManager, one of our goals is to create an investment plan that spans much longer than three or four years – we are often trying to help investors reach their retirement goals that span the next twenty years or more. Doing so, we believe, can help investors avoid some of the mistakes uncovered by DALBAR’s research. If you find yourself switching strategies too often, or think it would be beneficial to partner with someone who takes a much longer-term approach, WrapManager could be a good fit for you. To talk with one of our Wealth Managers about our approach and how we build long-term investment plans, please call us today at 1-800-541-7774 or send an email to wealth@wrapmanager.com.
Source:
1. DALBAR's 22nd Annual Quantitative Analysis of Investor Behavior
