For nearly 25 years, DALBAR Inc. (DALBAR), a financial services market research firm, has released a Quantitative Analysis of Investor Behavior (QAIB) report, which measures how investors’ decisions affected long-term performance in their portfolios. Throughout this time, DALBAR has identified two common mistakes investors make:
- Moving out of long-term investments after short periods of time, and
- Attempting to time the market.
Time is on your side – if you stay invested
It is often said that time is one of the biggest assets of the individual investor. With time, you can grow your savings through the power of compounding. You can also take advantage of the fact that markets tend to rise over the long term. Yet DALBAR reports that the average mutual fund investor has not remained invested for a sufficient period of time to reap the benefits of a long-term plan.
On average, mutual fund retention rates are much lower than long-term investment horizons
Source: “Quantitative Analysis of Investor Behavior, 2020,” DALBAR, Inc. www.dalbar.com
Did you know? In 2019, the average equity mutual fund investor managed to stay invested for 4.5 years while the average fixed income investor remained invested for 3.6 years. Clients invested in balanced funds appeared to have more confidence in their position – staying the course for just over 5 years – although this remains well below the threshold of what constitutes a long-term plan. 1
This tendency can have a negative impact on investor returns. Why? Volatility – that is, the ups and downs in the market – has historically been higher over shorter periods of time. As time goes on, the impact of volatility becomes less noticeable and investors have been rewarded for staying the course.
Volatility decreases over time
Source: RBC GAM, Morningstar. Rolling monthly returns as of January 1980 to July 2020. Based on a balanced portfolio comprised of 60% S&P 500 TR and 40% Bloomberg Barclays Aggregate Bond Index, rebalanced monthly (USD). An investment cannot be made directly into an index. The above does not reflect transaction costs, investment management fees or taxes. If such costs and fees were reflected, returns would be lower. Past performance is not a guarantee of future results.
Market timing is rarely perfect
Often market conditions prompt investors to try to time the market. But DALBAR’s research shows they often act in a way that runs counter to the eventual direction of the market. For example, investors may sell after markets have declined -- only to watch the recovery from the sidelines. Discouraged by their losses, it takes them a long time to recover their confidence and get back in the market. To assess the impact of these mistakes, DALBAR calculated the Guess Right Ratio. This involved looking at the movement of investment dollars in and out of mutual funds to see how often investors correctly anticipated the direction of the market in the following month. Although the market trended upward through much of 2019, investors still guessed only three out of 12 months correctly. This was the lowest ratio in the last 20 years.
The true cost of bad timing
Investors have incurred significant costs associated by not staying invested or trying to time the market. In the past 20 years, the average balanced-fund investor has experienced an annual rate of return that is 3.1% lower than what they would have achieved had they stayed the course. Based on an initial investment of $100,000 on January 1, 2000 excluding fees, this would add up to a difference of over $134,927 at the end of 2019.
There are real costs associated with trying to time the market
Source: “Quantitative Analysis of Investor Behavior, 2020,” DALBAR, Inc. www.dalbar.com 2
It’s natural to be anxious during uncertain markets. In times like these, the importance of having a professional advisor and a long-term plan becomes clear. Your advisor can share experiences and provide advice during difficult times, helping you stay on track. Studies show that investors who worked with an advisor over a 15-year period accumulated almost four times the wealth of investors who didn’t.³ An advisor helps you pinpoint your objectives, your tolerance for risk and your timeline for investing. This makes it easier to build a portfolio that will help you achieve your goals over the long term.