Investors Trail Funds by 1.9% Per Year
- Rick Ferri
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Investors Trail Funds by 1.9% Per Year
In a recently released article entitled “Past Performance is Indicative of Future Beliefs”,Philip Maymin and Gregg Fisher investigate how the aggregated timing of buying and selling by mutual fund investors affects their average returns. Using monthly returns and assets for approximately 25,000 mutual funds over the period November 1995 through October 2010, investors lost about 1.9% due to poor buy and sell decisions.
Here is a fact summary provided by CXO Advisory:
■ Over the entire sample period, for all types of mutual funds, the average fund investor sacrifices about 1.9% annually to poor market timing.
■ This poor timing derives essentially from replacing recent underperforming funds with recent outperforming funds. For example, peak net inflows to bond funds occur after equity bear markets in 2002 and 2008-2009.
■ A model assuming that a one-year “memory” of past returns triggers investor actions effectively explains the bad timing behavior.
■ The study infers that buy and hold investors fared better than those who attempted to time the sale and purchase of funds.
Rick Ferri
Here is a fact summary provided by CXO Advisory:
■ Over the entire sample period, for all types of mutual funds, the average fund investor sacrifices about 1.9% annually to poor market timing.
■ This poor timing derives essentially from replacing recent underperforming funds with recent outperforming funds. For example, peak net inflows to bond funds occur after equity bear markets in 2002 and 2008-2009.
■ A model assuming that a one-year “memory” of past returns triggers investor actions effectively explains the bad timing behavior.
■ The study infers that buy and hold investors fared better than those who attempted to time the sale and purchase of funds.
Rick Ferri
The Education of an Index Investor: born in darkness, finds indexing enlightenment, overcomplicates everything, embraces simplicity.
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I like the chart in the cited paper which shows the decomposition of the 15 year annualized return of the S&P 500 of 6.75%:
Inflation - 2.38%
Investor Behavior - 1.91%
Average Tax Cost - 1.63%
Expense Ratio - 0.81%
Net Return to Investor - 0.02%
Let's see - a low cost, broad based index fund held (forever) in a tax sheltered account seems to be a good bet at maximizing real return to an investor. Sounds familiar.
Inflation - 2.38%
Investor Behavior - 1.91%
Average Tax Cost - 1.63%
Expense Ratio - 0.81%
Net Return to Investor - 0.02%
Let's see - a low cost, broad based index fund held (forever) in a tax sheltered account seems to be a good bet at maximizing real return to an investor. Sounds familiar.
FI is the best revenge. LBYM. Invest the rest. Stay the course. Die anyway. - PS: The cavalry isn't coming, kids. You are on your own.
- Rick Ferri
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Hedge funds, private wealth funds, trading desks, and, ironically, investors using buy, hold and rebalance strategy over the same period added about 1.9% per year over a buy, hold and do nothing strategy.richard wrote:If one group is consistently underperforming the market by 1.9% per year, another group must be consistently beating the market by enough to make everything balance (all investors as a whole must equal the market performance, before costs).
What is the market beating group?
Rick Ferri
The Education of an Index Investor: born in darkness, finds indexing enlightenment, overcomplicates everything, embraces simplicity.
Here at Xerty's Financial Non-Management services, you need to submit requests to change your AA 6 months in advance for processing. It's for Your Own Good (TM).Trebor wrote:I would not be surprised if "advisors" as a group do just as bad. Finding a "good" boglehead type advisor probably isn't as easy as it seems.
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My quickie googling says that Hedge funds and Mutual Funds have roughly similar market caps of around $2T each. So doesn't that indicate Hedge funds are beating the market by 1.9%?richard wrote:
If one group is consistently underperforming the market by 1.9% per year, another group must be consistently beating the market by enough to make everything balance (all investors as a whole must equal the market performance, before costs).
What is the market beating group?
Rick Ferri wrote:
Hedge funds, private wealth funds, trading desks, and, ironically, investors using buy, hold and rebalance strategy over the same period added about 1.9% per year over a buy, hold and do nothing strategy.
Of course, with 2 and 20 fees the Hedge fund investors still don't.
JW
And, the pie chart leaves out trading costs (not part of a mutual fund's stated ER).RadAudit wrote:I like the chart in the cited paper which shows the decomposition of the 15 year annualized return of the S&P 500 of 6.75%:
Inflation - 2.38%
Investor Behavior - 1.91%
Average Tax Cost - 1.63%
Expense Ratio - 0.81%
Net Return to Investor - 0.02%
Let's see - a low cost, broad based index fund held (forever) in a tax sheltered account seems to be a good bet at maximizing real return to an investor. Sounds familiar.
So, average investor return is almost certainly negative.
Last edited by fishndoc on Fri Feb 04, 2011 9:54 am, edited 1 time in total.
" Successful investing involves doing just a few things right, and avoiding serious mistakes." - J. Bogle
After all the bad things we've heard throughout the years from you and other advisors about hedge funds, etc., we now find they're actually beating the market by a fair margin. One even hears their costs are coming down.Rick Ferri wrote:Hedge funds, private wealth funds, trading desks, and, ironically, investors using buy, hold and rebalance strategy over the same period added about 1.9% per year over a buy, hold and do nothing strategy.richard wrote:If one group is consistently underperforming the market by 1.9% per year, another group must be consistently beating the market by enough to make everything balance (all investors as a whole must equal the market performance, before costs).
What is the market beating group?
How can buy, hold and do nothing underperform the funds they're invested in? By definition they should exactly match (give or take reinvesting dividends).
The cynical would say financial advisors have an incentive to tout papers that show the value of advisors. The Dalbar study is the classic example of the cynical being right.xerty24 wrote:A consequence of this is that financial advisors charging only 1% AUM fees to keep their clients in a buy & hold strategy are providing good value for their customers, even if they do nothing else.
On the other hand, many need help to avoid self-destructive investing behavior.
I had a similar post last yearxerty24 wrote:Here at Xerty's Financial Non-Management services, you need to submit requests to change your AA 6 months in advance for processing. It's for Your Own Good (TM).
http://www.bogleheads.org/forum/viewtop ... 22&start=0
Your version is much more direct.
Maybe the lost 1.9% increases performance for everyone else. Similar to the fee when buying or selling Vanguard's International Smallcap fund: the fee is added into the fund for the other investors.
So if you buy&hold, or if you buy&hold&rebalance, your return is assisted by those investors who buy high and sell low. If they weren't in the market, then returns would be lower.
I'm not sure you need to buy low and sell high, or be a hedge fund, to gain from those who lose to emotional investing.
So if you buy&hold, or if you buy&hold&rebalance, your return is assisted by those investors who buy high and sell low. If they weren't in the market, then returns would be lower.
I'm not sure you need to buy low and sell high, or be a hedge fund, to gain from those who lose to emotional investing.
Wall street beats the market by taking the extra money from under educated investors.richard wrote:If one group is consistently underperforming the market by 1.9% per year, another group must be consistently beating the market by enough to make everything balance (all investors as a whole must equal the market performance, before costs).
What is the market beating group?
Even educators need education. And some can be hard headed to the point of needing time out.
Simple, looks at how your funds/ETFs have done for the time period compared to your returns.livesoft wrote:The market beating group has folks who buy on really bad days.
How do you know which group you belong to if you do not benchmark your portfolio?
Even educators need education. And some can be hard headed to the point of needing time out.
Based on a quick read the article's authors' primary interest is in putting forward a deductive model rather than in empirics.
As a result, there's really only a little bit about the dataset and no split-sample or out-of-sample checks on the 1.91% calculation.
Question: Is this finding highly sensitive to the 15-year study period?
Answer: Yes.
Evidence: See VTSMX investor returns over 3, 5, 10 and 15 year periods
http://performance.morningstar.com/fund ... -US&s=SPYZ
Conclusion of 15-year study: VTSMX investors are idiots! Stupider than average because they trail the fund by 2.19% per annum.
Conclusion of 3, 5 and/or 10-year study: VTSMX investors are geniuses! Investor returns BEAT the fund over all three study periods. And by as much as 1.57% per annum!
All best,
Pete
As a result, there's really only a little bit about the dataset and no split-sample or out-of-sample checks on the 1.91% calculation.
So the basic finding is that, among funds that are at least 15 years old, investors have done 1.91% worse than the funds over a 15 year study period (perhaps because they performance-chased, as I agree many did in the late 90's, but perhaps also because they got liquidated, retired, etc.)Taking the 24,719 mutual funds from Morningstar data that had at least some assets data and some returns data during the past fifteen years, we calculate the rolling annual fund returns and average investor returns using the calculations described in Appendix A. For each rolling window of 13 months (the first month is required to know the initial asset size), we require complete data on assets and on returns. However, to minimize possible survivorship bias, we only require this complete data on each 13-month rolling window; we do not require funds to have all data for every month for the past fifteen years.
Question: Is this finding highly sensitive to the 15-year study period?
Answer: Yes.
Evidence: See VTSMX investor returns over 3, 5, 10 and 15 year periods
http://performance.morningstar.com/fund ... -US&s=SPYZ
Conclusion of 15-year study: VTSMX investors are idiots! Stupider than average because they trail the fund by 2.19% per annum.
Conclusion of 3, 5 and/or 10-year study: VTSMX investors are geniuses! Investor returns BEAT the fund over all three study periods. And by as much as 1.57% per annum!
All best,
Pete
The investors aren't underperforming the market; they are underperforming the funds. If Fund A gains 20% with a $1B portfolio and Fund B gains nothing with a $3B portfolio, investors switch $2B from Fund B to Fund A, and now Fund A gains nothing and Fund B gains 20%, the market went from $4M to $4.4M, a 10% gain over two years (4.9% annualized), even though both funds reported a 20% gain over the two years (9.1% annualized).richard wrote:If one group is consistently underperforming the market by 1.9% per year, another group must be consistently beating the market by enough to make everything balance (all investors as a whole must equal the market performance, before costs).
What is the market beating group?
- asset_chaos
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- pointyhairedboss
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Question: Even if investors behaved rationally, wouldn't they still under perform the market (albeit to a smaller amount)?
Consider:
- Stocks outperform bonds over the long term.
- When rebalancing, investors will typically sell shares from stock funds and into bond funds. Over the long time, the stock funds will continue to outperform, and the investor won't get all the outperformance as they have sold a portion of it.
Consider:
- Stocks outperform bonds over the long term.
- When rebalancing, investors will typically sell shares from stock funds and into bond funds. Over the long time, the stock funds will continue to outperform, and the investor won't get all the outperformance as they have sold a portion of it.
The aggregate of all funds should be a good approximation of the market. If there's a major disconnect, then something odd is going on.grabiner wrote:The investors aren't underperforming the market; they are underperforming the funds. If Fund A gains 20% with a $1B portfolio and Fund B gains nothing with a $3B portfolio, investors switch $2B from Fund B to Fund A, and now Fund A gains nothing and Fund B gains 20%, the market went from $4M to $4.4M, a 10% gain over two years (4.9% annualized), even though both funds reported a 20% gain over the two years (9.1% annualized).richard wrote:If one group is consistently underperforming the market by 1.9% per year, another group must be consistently beating the market by enough to make everything balance (all investors as a whole must equal the market performance, before costs).
What is the market beating group?
asset_chaos wrote:I am not astonished that market timing of any kind produces poor results in aggregate,
Investors in the aggregate are the market. Beating the market is a zero sum game (before costs). Individual investors can easily underperform the market, but it's hard to see how all investors can underperform the market, i.e., all investors (again, before costs).pointyhairedboss wrote:Question: Even if investors behaved rationally, wouldn't they still under perform the market (albeit to a smaller amount)?
Consider:
- Stocks outperform bonds over the long term.
- When rebalancing, investors will typically sell shares from stock funds and into bond funds. Over the long time, the stock funds will continue to outperform, and the investor won't get all the outperformance as they have sold a portion of it.