And the gap between active manager and investor has become even larger. In recent months aging investors, many closing in on retirement, piled into cash afraid of the market’s dizzying heights and breakneck volatility. Over the last 12 months ending September 30, 2018, the average equity fund investor earned only 11 percent. But the average actively managed equity fund made 15.19 percent—that’s a 41 percent difference. Possible reasons for the sharp difference are today’s apparent ease of converting equity holdings to cash; it’s just a click away. “Before we were having a bumpy road. Now we’re witnessing whiplash,” said DALBAR’s CEO.
Individuals have become ultra-tuned to the trends thanks to broadcast financial journalism. That leaves them vulnerable to stampeding in the service of ratings, like they did when the Ebola scare stories pressed airline stocks like American Airlines down to unprecedented lows, only to see the shares bounce back soon after the panic stopped. How many times since the Financial Crisis have we allegedly been going into a recession or worse?
Investors lose because they move at precisely the wrong time, buying when they should be selling, selling when they should be buying. They let emotions or opinions of others alter their long-term investment strategy. “The data shows that the average mutual fund investor has not stayed invested for a long enough period of time to execute a long-term strategy. In fact, they typically stay invested for just a fraction of the market cycle,” the DALBAR 2017 report said. Essentially the long-term investor is a thing of the past.
When investors buy an active manager or an advisor who chooses to be somewhat different than the markets they are trying to outperform, they’re counting on the manager to exercise skills and experience accumulated over years of successful investing. They count on them to do everything they can to protect long-range returns. To an active manager heavily invested in his own venture, losses are not academic.
Most of all the investors are admitting their financial ship needs a pilot and that they are hiring one with the best style that suits their needs. They stop chasing performance. And they let their pilot do their job over at least a five-year span or even longer. They focus upon long-term goals, not short term gyrations and noise.
“What my studies call for is a trusted third party,” said Harvey. “The individual investor is not going to be up on the latest information. The manufacturers of financial products want to gather assets and sell products. Their goals are opposite that of the investor.” Their overarching goal is to maximize assets in their products; the intrinsic values of their individual holdings are of no concern to them.
And even though the federal court has struck down the Department of Labor’s fiduciary rules, active managers and advisors have always had a fiduciary obligation to their clients. The promise: We put the clients’ interest ahead of our own. However, brokers and fund companies still do not have a fiduciary duty.
When you buy an index, you are paying to have your boat floated down the stream without the services of a captain, or even a guardian. In times of crisis you rely on your own resources. We see that this can only bring underperformance, as successful investing requires constant attention.
DALBAR shows that individual investors have proven poorly qualified to chart their own course in financial markets; attempting to do a full-time job in their spare time without the necessary experience. By the time investors find out their errors, it is too late.
Where Do We Go From Here?