What you don’t know about DALBAR’s 9 percent stock return

By Chris Conklin

Insurance Insight Group


Until recently, I personally followed an investment strategy that was very much what DALBAR advocates: I was a true buy-and-hold investor. But at the end of last year, I started really thinking about what I was doing, and as an actuary, part of my usual thinking process is running numbers.

Can what you don’t know hurt you — or your clients? Of course it can.

DALBAR, a market research firm, publishes a study showing that stock mutual fund investors consistently underperform the S&P 500 index, and that if people would have just unemotionally bought and held, they would have achieved a 9 percent stock return over the last 20 years.

But is that true? Not necessarily, as you will see.

What DALBAR says

The latest edition of the DALBAR Quantitative Analysis of Investor Behavior notes that the S&P 500’s annual return over the last 20 years, including reinvested dividends, has been 9.14 percent. However, the actual return achieved by the average mutual fund investor has been only 3.83 percent.

The DALBAR study has been conducted annually for the past 17 years, and this year’s study noted that every year, they have found that “mutual fund investors consistently underperform the relevant index” and that “most of this loss in performance is due to psychological factors that translate into poor timing of their buys and sells.”

There is not necessarily anything wrong with what DALBAR has said. The danger is in how we extend this information beyond what DALBAR has said.

For example, one common implication is that true buy-and-hold investors would have actually achieved a 9 percent stock return over the past 20 years. As you will see, that is not necessarily the case.

I asked, “What about me?”

Until recently, I personally followed an investment strategy that was very much what DALBAR advocates: I was a true buy-and-hold investor. I opened my first stock mutual fund account over 20 years ago and regularly added money to it as I had money available. As the market crashed twice in the last decade, I did not deviate from the plan, holding fast to the belief that the market would recover. I consistently had the great majority of my assets in equities.

But at the end of last year, I started really thinking about what I was doing, and as an actuary, part of my usual thinking process is running numbers. One set of numbers that I ran was particularly revealing. I simply figured out what average annual rate of return I had actually achieved over my lifetime. In my case, it was about 5 percent. I then checked to see what rate of return I would have achieved if I had simply invested impassively in the S&P 500 index. It would have been lower.

So this got me thinking, “I follow closely what DALBAR advocates, and in fact, the few minor asset allocation decisions I have made have allowed me to beat the S&P 500 index, yet my rate of return has only been 5 percent. What’s up with that?”

What you don’t know about that 9 percent stock return

Here is where it gets interesting.

If I had a lump sum of savings invested in the S&P 500 index on Jan. 1, 1991 and left it there to accumulate with price appreciation and dividends for 20 years, it would indeed have grown at an annualized rate of 9.14 percent, just as DALBAR says.

However, is that typical of myself or most people? No! What working-age people generally do is build up their savings and investments over time, adding an increasing amount to their savings as they grow increasingly prosperous in their careers.

So what happens if I change DALBAR’s assumption a little bit? Rather than assuming that a person puts in an amount of money 20 years ago and never adds or takes out money thereafter, let’s instead assume that someone put $1,000 into their stock mutual fund at the beginning of 1991 and then added an increasing contribution each year. Let’s assume they put in $2,000 at the beginning of 1992, $3,000 at the beginning of 1993, and so on each year, so that they put in $20,000 at the beginning of 2010.

The rate of return they would have achieved was 5.18 percent, far short of the 9.14 percent DALBAR quotes.

Notice that they did not make any timing decisions. They did not base any action on psychological factors. They merely put money into their stock mutual funds as they had money available to invest, and in their case, that happened to be an increasing amount annually over time.

Don’t just take my word for it. You can see all of these numbers in the charts below.





Implications

The implication for me personally was that I became considerably less thrilled with my simple buy-and-hold investment strategy, and I decided to make some dramatic changes to what I was going to do going forward.

If your clients have saved their account statements, you can run their numbers and they may be shocked to find that they didn’t come close to achieving a 9 percent rate of return.

And that realization will make stable-value products that provide a predictable rate of return appear far more attractive than those products may have seemed to your clients previously.

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