I regularly push back on the “buy and hold” investing meme because while it works in “theory,” reality has a far different outcome. This is not my opinion, it is the reality of human emotion and psychology as it impacts portfolio management over time. The annual Dalbar Investor survey shows the massive performance lag of individuals not only in the short-term but in the long-term as well.
· In 2015, the 20-year annualized S&P return was 8.19% while the 20-year annualized return for the average equity mutual fund investor was only 4.67%, a gap of 3.52%.
Here is a visual of the lag between expectations and reality.
Importantly, THERE IS NO evidence linking investment recommendations to average investor underperformance. Analysis of the underperformance shows that investor behavior is the number one cause, with fees being the second leading cause.
There are THREE reasons why “buy and hold” investment strategies DO NOT WORK according to the Dalbar study:
So, why am I bringing this up?
After recently pinging on the fallacy of “passive investing,” because you are not passive, I invariably receive push back from advisors who cling to the hope that markets will continue to rise indefinitely. Such as this one:
“Just caught up with your latest effort in the fake news category. The thrust of your argument seems to be, wrongly as usual, that active outperforms passive in bear markets.” – Brent
Actually, no, that is not my argument.
My consistent argument is individuals, like Brent, mislead themselves, or their clients, by suggesting they will get average rates of return over time. They won’t and they don’t.
Markets do NOT compound returns, you do not get average returns, and you do not have 100-plus years to reach your goal.
Investing without a discipline or skill set is easy when the “bull market” is running. It is when the next “bear market” growls where individuals will be decimated as the mean reverting event takes its toll. As history proves, everyone has a threshold of pain – and bear markets always exert the pain required to force investors out near the bottom.
This is just reality and why protecting capital during market declines is much more critical that chasing returns during market advances.
Furthermore, there is substantial evidence that a good manager with the right skill set can outperform over time. It took me about 5-minutes with a screener to find mutual funds that have outperformed the Vanguard S&P Index fund over the last 20-years.
Take the best performing fund over the last 20-years out of our group above. Sequoia has had a rough couple of years and is severely underperforming the market in the short-term. According to the current mentality, you should sell that fund and buy a passive index ETF. Why pay a fee for an underperforming fund. Right?
That decision would have cost you dearly coming out of the financial crisis.
As is always the case, a ramping bull market hides investor mistakes – it is the bear market that reveals them. However, it is psychology and fees that are the leading causes of underperformance during a bull market advance.
Investors need to be cognizant of, and understand why, the chorus of arguments in favor of short-sighted and flawed strategies are so prevalent. The meteoric rise in passive investing is one such “strategy” sending an important and timely warning.
Just remember, everyone is “passive” until the selling begins.
Lance Roberts is a chief portfolio strategist and economist for Clarity Financial.
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