Successful Investors Keep the Faith
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“Keep the faith!”
Long-term clients have seen or heard this phrase from us in a blog post or quarterly letter or meeting. It is a favorite saying of ours because it is simple advice that leads to very real value for any investor; whether they are a client or not.
Study after study shows that investors consistently underperform market indexes. The Dalbar Quantitative Analysis of Investor Behavior found that the average equity mutual fund investor underperformed the S&P 500 by nearly 4%. The average fixed income mutual fund investor underperformed the Barclays Aggregate Bond Index by about the same amount.
Morningstar found that investors underperformed relevant benchmarks across all asset classes with an average annual underperformance of 2.5% over 10 years. Money moved out of equity mutual funds in 2009, at the bottom of the market, and flew back into equity mutual funds in 2013, after a huge, 30%+ year for stocks.
Sell low, buy high.
Vanguard studied investor behavior in their IRA accounts during the Financial Crisis and its aftermath. They found investors who made just one move lagged the Vanguard asset allocation benchmark by 104 basis points or 1.04%. In contrast, investors who stuck it out beat the same benchmark by 33 basis points.
The common theme is that investors underperform and do this largely because of self-inflicted, easy to make mistakes ingrained in the human psyche.
From an evolutionary standpoint, we are hardwired to feel the pain from losses more than joy from gains. While this kept our hunter and gatherer ancestors alive, it leads to bad investment behavior. Like the investors who ran out of stocks in 2009 and piled back in 2013, the same thing happens when active managers underperform.
Eighty-five percent of the best investment managers underperformed over three years, often substantially, despite ultimately delivering top 90th percentile performance. Successful active strategies should be expected to underperform for sometimes extended periods. As investors, we must realize ahead of time that it will be challenging to keep the faith during these times but that keeping the faith is our best chance at realizing the long-term returns of the strategy.
Otherwise, it is all too easy to fall prey to the Behavior Gap.
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