My recent post titled To Index, Or Not To Index: That Is The Question! focused on the fact that most actively-managed mutual funds fail to outperform their benchmarks. It’s bad enough that most funds underperform the market, but what’s worse is that investors often underperform their own investments!
The Quantitative Analysis of Investor Behavior (QAIB) is a report that Dalbar, a financial research company, has published since 1994. This study compares the performance of individual investors against market indexes by analyzing the timing of mutual fund purchases and redemptions. The QAIB reports show that the average investor underperforms the market on a regular basis.
Since most investors use actively-managed funds, and the majority of actively-managed funds underperform the market, the fact that the average investor underperforms the market shouldn’t come as a surprise. But how do investors do compared to their own investments?
According to Lipper, a company that provides research information on mutual funds, the average stock fund returned 9.1% per year from 1995 through 2014. (Keep in mind this figure doesn’t include the performance figures of funds that were closed or merged out of existence.) Over the same time frame, the average stock fund investor only earned 5.0% per year according to the 2014 Dalbar QAIB study.
Average Stock Fund Return vs. Average Stock Fund Investor Return (From 1995 through 2014)
| Average Stock Fund Return | Average Stock Fund Investor Return | Penalty for Bad Behavior |
| 9.1% | 5.2% | (3.9%) |
From 1995 through 2014, the average stock fund investor underperformed the average stock mutual fund by 3.9% per year. At 9.1% per year – which is the performance of the average fund – an initial investment of $100,000 would have grown to $570,815 over this 20-year time frame. The 5.2% return that the average stock fund investor realized would have turned the same $100,000 into only $275,623!
How It’s Possible To Underperform Your Own Investments
Assume Mr. Anxious invested $100,000 in the Vanguard 500 Index Fund (VFINX) at the end of 2008. After seeing his investment lose money in January and February – and after hearing his co-workers tell him he was crazy for being in the market – he decided to sell his shares at the end of February.
The market hit a bottom in March and started an upward trend, so Mr. Anxious decided to reinvest his money at the end of April. At the end of the year, with all dividends and capital gains reinvested, Mr. Anxious had earned 6.17% on his money, turning his $100,000 investment into $106,170.
The mutual fund Mr. Anxious was using, the Vanguard 500 Index Fund, earned 26.49% during 2009. Unfortunately Mr. Anxious only earned 6.17% due to the fact he sold his shares during a downturn only to buy back later at a higher price. His behavior caused him to underperform his own mutual fund.
In this example, Mr. Anxious could have turned his initial $100,000 investment into $126,490 in 2009 if he had followed a buy-and-hold strategy throughout the year instead of reacting to the ups and downs.
The average investor tends to underperform the average mutual fund due to behavior. Investors – spurred on by friends, co-workers, and the financial media – are constantly chasing performance and trying to time the market. That type of behavior can lead to buying high, selling low, and ultimately underperforming your own investments.
Average stock fund return and average stock fund investor return from Lipper and Dalbar respectively. Return figures are annualized. This illustration is for educational purposes only and past performance is not indicative of future returns.