This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Rusty Vanneman, CFA, CMT, chief investment officer; and Dustin Dorhout, junior investment research analyst, of Omaha, Nebraska-based CLS Investments.
When it comes to investor returns, data from various sources tells the same tale: The average investors has significantly underperformed the 20-year annualized returns of major asset classes.
For reference, a U.S.-based, balanced portfolio (60% stocks/40% bonds) would have returned about 5.5% over this 20-year time frame, but the average investor gained less than 2%. That’s what we mean by “significant” underperformance—a whopping shortfall of about 3.5% per year.
If we were reviewing a globally balanced, multi-asset portfolio—which includes international stocks, real estate, alternatives, high-yield bonds, and commodities—the underperformance would be even steeper. That’s a painful truth.
So, why does the average U.S. investor face such a hefty shortfall against the market?
Fees Matter, But Behavior Is Key
Much is said about investment fees, and of course, all else being equal, lower fees are unequivocally better. But there is too much concern over fees.
Too much money is in constant motion simply because investors are searching for lower fees, and this money may move into inferior investment products. The typical mutual fund or ETF fee is less than 1%. But if pricier funds are well-understood and used, they may pay for themselves several times over.
Active management often takes a lot of the blame for investor underperformance. This style of management, which deviates from an index in search of different or better returns, underperforms over time. But that underperformance can primarily, if not entirely, be explained by fees and “cash drag” (active managers typically have some cash in portfolios).
We believe the most significant contributing factor to investor underperformance is that investors routinely chase performance.
This “behavior gap” accounts for about 2% or more of underperformance per year, in our view. This makes up the lion’s share of the average investor’s shortfall in returns.
In the table below, you can see the strong performance of high-growth emerging markets. Also noteworthy is the strength of hybrid asset classes, such as real estate and high-yield bonds, which are not held in many conventional, balanced portfolios. The performance of long-term government bonds is also noteworthy, but investors should not expect continued strength in this sector, as yields are now significantly lower.
There are ETFs accessing all of these asset classes. Here are some of the largest ETFs in each one of them:
What To Expect From Next 20 Years
Investors fell short on an annualized basis in the past 20 years. Will the next 20 years look like the past 20?
Ideally, individual investors would do a lot better. But human nature is what it is, so we should still expect a “behavior gap” as investors chase performance, bypassing opportunities in asset classes when they are “on sale.”
That said, as for relative performance of asset classes, we still expect emerging markets to lead given higher expected economic growth rates coupled with more attractive valuations.
A few of these other asset classes, though, might surprise us going forward.
First, it would not be unreasonable for commodities to do a lot better in the years ahead as they recover from what’s been a brutally long bear market in recent years.
Developed international stocks will also likely offer solid returns against U.S. stocks. Bonds will still most likely generate positive returns, but they will likely generate lower returns than what we have seen over the past 20 years.
Top ETF Picks
While often not the biggest and most popular choices, here are some of our favorite ETFs to access each of these markets:
This information is prepared for general information only. Information contained herein is derived from sources we believe to be reliable; however, we do not represent that this information is complete or accurate, and it should not be relied upon as such. All opinions expressed herein are subject to change without notice. The graphs and charts contained in this work are for informational purposes only. No graph or chart should be regarded as a guide to investing.