Ferri: Avoid Being An Out-Of-Style Investor

September 16, 2014

Chasing investing styles is chasing performance, and investors shouldn't do it.

Beating the market using mutual funds isn’t easy. The hope of finding fund managers who steadily beat their benchmarks may seem like a worthwhile venture, but the only people who seem to earn steady profits from active mutual fund strategies are companies selling products. A persistent “performance gap” exists between investor returns and the returns of the funds they invest in.

I talked about the performance gap in my 1999 book, Serious Money. At the time, DALBAR measured the gap for U.S. equity fund investors to be about 7 percent annually relative to the return of the average equity fund, and more than 9 percent annually versus the S&P 500.

This gap still exists, although it has been whittled down somewhat due to the greater use of low-cost index funds and exchange-traded funds. DALBAR’s 2014 annual Quantitative Analysis of Investor Behavior (QAIB) measured the performance gap for U.S. equity fund investors at 4.2 percent annualized over a 20-year period ending in 2013. DALBAR also reported the S&P 500 had a return of 9.22 percent annually, while the average U.S. stock mutual fund investor earned only 5.02 percent.

DALBAR’s QAIB results have always been the subject of criticism. Some people believe the methodology overstates the problem. Even if this were true, other sources confirm the existence and persistence of a performance gap.

Morningstar found U.S. equity fund investors trailed the average U.S. equity fund return by 1.66 percent annualized over a 10-year period ending in 2013. The firm reported that all funds combined had a performance gap of 2.49 percent during the same period. This was an increase over 2012 data.

DALBAR blames about half the performance gap on “psychological factors” resulting in bad investor behavior. They blame the other half on practical reasons such as not having money to invest and needing money for other purposes. A breakdown of these factors is explained in this 2013 QAIB study.

This article attempts to answer this question: What, exactly, are active fund investors doing wrong?

 

 

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