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By Angela Barnes
The Globe And Mail
Saturday, July 26, 2003
Most investors in stock mutual funds aren't
very good at timing the market. They tend to chase
performance and because of that, the returns on
their investments haven't even kept up with inflation
or market indexes over time.
Those were the key findings of the 2003 survey
done by Boston-based financial services market
research firm, Dalbar Inc.
Adrian Mastracci, president
of Vancouver based ‘fee-only’ KCM
Wealth Management, says, "Only a small percentage
of investors can successfully time the market.”
The study found that the average U.S. equity
fund investor earned just 2.57 per cent annually
between 1984 and 2002, which was below the 3.14-per-cent
average annual inflation rate. It pales even more
against the 12.22-per-cent annual return of the
Standard & Poor's 500-stock index over the
19 years.
The average investor earned only a fraction of
the stock indexes' returns, "primarily because
investors did not invest for the long term,"
said Heather Hopkins, director of marketing for
Dalbar. Yet mutual funds are marketed as long-term
investment vehicles; their five- and 10-year performance
figures are displayed in advertising and annual
reports and furthermore, investors' expectations
of the returns they can earn are based on the
philosophy of holding mutual funds for the long
term, she noted.
"However, actual investor behaviour belies
their expectations," she said in the report.
Investors' decisions to get into or out of mutual
funds were motivated primarily by swings in the
market, but the end result was that they tended
to buy high and sell low.
"Investment return is far more dependent
on investment behaviour than on fund performance,"
Ms. Hopkins said. "Mutual fund investors
who simply remained invested earned higher real
investor returns than those who attempted to time
the market," she said.
In determining returns, Dalbar looked at the
flows in and out of mutual funds to determine
the average length of time unitholders actually
remain invested in a fund and then applied that
to the returns for the appropriate index on a
monthly basis to come up with an average real
return. The firm found that the length of time
an average equity investor in the United States
sticks with a fund is just about 2½ years,
the shortest retention period since 1988.
The average investor in a fixed income fund holds
the fund longer -- about three years. (Because
of that, the average fixed-income fund investor
fared better than the average equity fund investor,
earning an annual return of 4.24 per cent but
that pales in comparison with the 11.7-per-cent
return of the long-term government bond index.)
Investors' propensity to lose their cool when
the markets fall shows up in the cash flow data.
"With few exceptions, monthly cash flows
decrease when markets show a negative return and
increase when the market rises," Ms. Hopkins
said.
Matthew Elder, vice-president, content and editorial,
at Morningstar Canada, said the Dalbar study is
not the first one to show that the typical investor
never does as well over the long term if he or
she employs an active buy-and-sell strategy rather
than a buy-and-hold approach.
"Active management by an investment professional
such as a mutual fund portfolio manager can add
considerable value over the long term, as opposed
to trying to pick securities on your own,"
he said. Accordingly, it's usually best to let
the experts make the market-timing decisions.
He admitted it is tough to buy and hold a fund
through bad times as well as good, but said performance
numbers show such discipline pays off in the long
run.
Warren Baldwin cited studies showing that if
the market returns, for example, 8 per cent annually
over a 10-year period, being absent from the market
for the 20 best days might reduce the return to
5 per cent. "You miss the best 40 days and
you are actually down to 3 per cent," he
said. Miss another 20 days and the return actually
could be negative, he added.
Rather than trying to time the market, investors
should spend time determining an appropriate asset
mix and then have the discipline to stick with
it. The mix should be reassessed and rebalanced
if needed to take money out of the strong performers
and put it into weaker ones, he said. Those adjustments
should be relatively modest unless the investor's
situation changes, he said.
The Dalbar study was done in the United States
but Mr. Baldwin felt that Canadian investors behave
much like their U.S. counterparts.
Adrian Mastracci, president
of KCM Wealth Management Inc.
of Vancouver, agreed. After looking at the Dalbar
study, he said "you could probably make the
case that really applies to Canada, too, in many
ways."
Only a small percentage of investors can successfully
time the market and he doesn't advise most to
try. Also, he said, "most investors unfortunately
tend to buy at the top" of the market, jumping
on the bandwagon at the same time as everyone
else.
Ms. Hopkins said that a study Dalbar did in Canada
in 2000 showed returns and holding periods were
very similar to those in the United States.
The latest Dalbar study also showed that fund
flows aren't directly affected by major political
and world events. "An examination of major
events over the last 19 years unveiled no discernable
correlation between a major event and trade volume,"
she said.
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