“The investor’s chief problem — and even his worst enemy — is likely to be himself,” quipped the great Benjamin Graham.
The truth of Graham’s observation is seen in the consistent pattern of mutual fund investors to self-destruct.
Over the past 30 years, the typical stock mutual fund investor’s performance has badly lagged the S&P 500 index, according to Dalbar’s Quantitative Analysis of Investor Behavior (QAIB) report. While the average mutual fund investor earned 3.69%, the S&P 500 earned 11.11%. What were the chief causes behind the significant undeperformance?
The underlying problem wasn’t the 1987 stock market crash, the 2000-2002 dot-com bursting, the 2008-09 financial crisis, nor poor economic conditions — but rather investor misbehavior. People chase historical performance, buy the wrong things at the wrong time, and have a knack for poor financial decision-making.
Curiously, one of the main advantages of mutual fund investing is supposed to be professional money management by seasoned pros. But people have found a plethora of ways to mess up even that.
Unfortunately, people who buy individual stocks aren’t that much better than people who buy mutual funds.
In a study conducted at the height of the dot-com frenzy by professors Brad M. Barber and Terrance Odean, they found:
- Households trade common stocks frequently. The average household turns over more than 75 percent of its common stock portfolio annually.
- Trading costs are high. The average round-trip trade in excess of $1,000 costs 3% in commissions and 1% in bid-ask spread.
- Households tilt their investments toward small, high-beta stocks. There is a less obvious tilt toward value stocks.
I recently caught up with Terrance Odean, who continues his groundbreaking research about investors’ habits at the University of California at Berkeley. In my video interview with Odean, he talks about a 14-year study of Asian daytraders and how it relates to individual investors in the U.S. and elsewhere.
It’s required viewing for anyone with designs on beating the market … or really, even just keeping up.
Follow us on Twitter @ ETFguide