Free Advice: D-I-Y Investment Approach Isn’t Worth the Savings
By Tony Batman, chairman & CEO, 1st Global
DALBAR released its Quantitative Analysis of Investor Behavior  (QAIB) report last month and the results of the study are shocking but - sadly - not very surprising.
First, a little background. DALBAR is an independent rating company that works specifically with the financial services industry. Its purpose is to offer unbiased, quantitative and reliable metrics of investment companies, insurance companies, broker-dealers and the people that work in this industry. One way they do this is by publishing the annual QAIB report. This report aims to quantify what the average investor actually recognizes in stock, bond and allocation funds. In other words, how does the average, do-it-yourself Joe on the street actually do? Of course, there is never a perfect methodology to measure gross investor returns, but DALBAR's approach is pretty sound.
The study looks at mutual fund sales, redemptions and exchanges every month as a measure of average investor behavior and then compares those purchases or redemptions against standardized benchmarks such as the S&P 500 and the Barclays Aggregate Bond Index. Once these two metrics are compared, a very clear picture emerges as to how the average investor fared against the marketplace.
- Loss Aversion: Expecting to find high returns with low risk.
- Narrow Framing: Making decisions without considering all implications.
- Anchoring: Relating to the familiar experiences, even when inappropriate.
- Mental Accounting: Taking undue risk in one area and avoiding rational risk in others.
- Diversification: Seeking to reduce risk, but simply using different sources.
- Herding: Copying the behavior of others even in the face of unfavorable outcomes.
- Regret: Treating errors of commission more seriously than errors of omission.
- Media Response: Tendency to react to news without reasonable examination.
- Optimism: Belief that good things happen to me and bad things happen to others.
And the picture isn't pretty - at all. First, let's look at the returns last year. In 2011, the Barclays Aggregate Bond Index returned 7.84 percent. So how did the average bond fund investor do? 1.34 percent. That's a whopping difference of 6.5 percent. OK, how about equity funds? The S&P 500 finished up 2.12 percent. The average investor? Negative 5.73 percent. The difference between those two (7.85 percent) is astounding.
The answer, of course, lies in the fact that these are challenging economic times. The market has experienced significant trouble recently and volatility has been at an all-time high. That must be the answer, right? Apparently not. Not only did investors underperform their benchmarks last year, they have underperformed for the last three-year, five-year, 10-year and 20-year periods on an annualized basis, in both equities and bonds. The average bond fund investor hasn't even kept up with inflation during these same time frames. Wow.
How can this be explained? There is certainly no shortage of information available to the average investor. CNBC provides up-to-the-minute market information with trailing ticker symbols at the bottom of the screen, insightful CEO interviews and market predictions galore. Using my iPhone, I can now download more information about some obscure small-stock company in Bangalore than was available to most wire-house firms just five years ago. So information is readily accessible.
Additionally, discount brokers are on just about every street corner in America now. Every do-it-yourselfer has access to no-load funds, saving anywhere from .3 percent to .8 percent or more over products recommended by professional financial advisors.
So with more information available on the Web, expert talking heads on TV and access to no-load funds, the average investors have finally been empowered! They can do it all themselves and do it better than the so-called professionals, right? Looking at the results from DALBAR, that's clearly not the case.
DALBAR asserts that the mistakes made by the average investor are much lower when the markets are moving up. Intuitively, we know this to be true. Think, for example, about the late 1990s. During the tech craze and dot-com bubble, everything was making money. It didn't really matter which fund you chose, as long as you were invested. If you just threw a dart at the board, you were in the black.
The challenge comes when things turn bad. Psychological factors (see sidebar) begin to take precedence and dictate the investor's decision-making process. Fear is an extremely powerful motivator, and as the QAIB study shows, it leads most investors to make irrational decisions that greatly harm their ability to reap the rewards of long-term investing. In other words, the benefits they assume they are generating by saving a fraction of a percentage point in costs are very quickly erased by the poor decisions they make when fear sets in.
Could average investors outperform the benchmark indices? Sure. They'll need to create a long-term strategic plan with access to professional money and fund managers, a proper asset allocation and the discipline to stay the course when times are both good and bad. How likely is it that they will actually follow through? As the DALBAR study shows, not very likely.
Ultimately, that's the value that professional and caring financial advisors really offers their clients. It's not access to the best mutual funds, although any competent advisors and their brokers/dealers will only work with world-class money managers. It's not the years of experience or certifications, although those certainly help. No, the real value a competent financial advisor brings is the ability to ask the right questions, create the right plans, bring the right players and solutions to the table and - perhaps most importantly - guide clients in such a way that their fears and worries don't derail their lifelong plans.
This article and its content have been provided by 1st Global. With more than 450 firms affiliated with 1st Global, it is one of the largest wealth management services partners for the tax, accounting and legal professions. 1st Global delivers the required capabilities essential for wealth management excellence including progressive ongoing education, which places the firm in a unique position to offer wealth management knowledge.
1st Global was founded by CPAs on the belief that accounting, tax and estate planning firms are uniquely qualified to provide comprehensive wealth management services to their clients. Each affiliated firm is provided with education, technology, business-building framework and client solutions that make these firms leaders in their professions through dedicated professional client relationships built around wealth management.
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