A twenty-year perspective for the recent market turbulence

Another powerful insight -- particularly in light of the recent market turbulence -- from the most-recently published Dalbar Quantitative Analysis of Investor Behavior (QAIB) is the fact that the average investor underperformance is greatest over long periods.

In a previous post, we discussed Dalbar's research which has consistently shown that most investors achieve unsatisfactory returns over long periods of time, which the Dalbar studies themselves say is due to the fact that "investor behavior erodes the returns on even the best performing fund."

The graph above includes not only those 20-year results which were shown in the previous post, but adds the perspective of short-term returns. The Dalbar study reveals that for short periods, such as one year, the average investor achieves comparable returns to the market. It is over long periods that investors sabotage their own performance by making mistakes driven by fear and other emotions, and particularly (the study notes) the mistake of selling during downturns.

The lesson of the study is often said to be that investors need professional advisors to help them, but as we noted, the people who provide the data for these Dalbar studies state that their research has indicated that about 80% of mutual fund investors (the source of the data) seek professional advice in their mutual fund decisions outside of retirement plans at work. So this problem is not at all limited to those without advisors but may well be caused in part by advisors!

The lesson of the study is also not simply that everyone should "just index." It is not the vehicle itself that is the problem, but the behavior. As Dalbar says, "investor behavior erodes the returns on even the best performing fund." Bailing out of an index fund when the market drops 20% will hurt you just as badly as bailing out of an actively-managed fund. And, we have argued elsewhere why we do not buy into the current index-fund bandwagon.

The lesson of the terrible long-term performance shown in the graph above is that the average investor (and the average advisor, according to our understanding of the data) is fairly capable at picking short-term performers, but does not have the consistency required to achieve long-term success.

If you look around at the panic taking place right now, and count the voices advising you from all angles to "take action" in order to "recession-proof" your portfolio or otherwise make changes to your investment process in light of the market's behavior, you can see why long-term success is so elusive.

It is easy to jump on something that has done well (which is why the average investor has a decent one-year track record) but it is much harder to stay true to a long-term process. Many investors (and many advisors) have no real consistent long-term process beyond finding what has done well lately and switching into that every couple of years.

We advise readers that the first critical requirement is to have a consistent discipline that is based on successful fundamental principles. The second is to realize that, if your allocations of capital are currently set in accordance with your various time horizons and cash-flow needs, then you don't need to panic and make wild changes during market turbulence. Those kinds of wild changes lead to the results in the graph above, and you don't want to go there.