Dalbar Update: Investors Still Lagging The Market
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    1. Third Quarter GDP Surprises on the Upside
    2. Why Investor Returns Can Trail the Market
    3. The 2009 Dalbar QAIB Study Update
    4. Investor Panic Leads to Poor Decisions
    5. A Chink in Passive Investing’s Armor?
    6. Same Study – Different Conclusions


    Since late 1994, studies have shown that many investors do not realize the same returns as the mutual funds in which they were investing.  The first such study I saw back in the 1990s was one that Martin Zweig commissioned Morningstar to produce.  This study analyzed cash flows in and out of stock mutual funds to see how the average investor did.  I remember being surprised when I learned that over the period from 1989 through 1994, the average growth mutual fund returned 12.5% but the average investor in those funds actually lost 2.2%.

    Soon, the Zweig/Morningstar study was joined by others, the most notable of which was the Quantitative Analysis of Investor Behavior (QAIB) Study conducted by Dalbar, Inc. in 1994.  Dalbar confirmed that many investors were not participating in long-term mutual fund returns because of frequent switching among funds. 

    Until these studies were published, no one worried too much about what kind of returns investors were actually realizing.  Everyone just assumed that whatever the large mutual fund firms reported as returns were what investors got.  These studies, however, showed that many investors were chasing hot returns in order to get better returns.  In other words, they’d jump from one hot fund to the other in hopes of increasing their return.  But just the opposite occurred.

    To say that these studies had a huge impact on my firm is an understatement, since they were the catalyst for the introduction of our AdvisorLink® Program back in 1995.  Fortunately, Dalbar has continued to update its original study each year, and the general trend has remained the same – investors overall are not getting the kind of returns they should because of frequent switching among funds.

    This week, I’m going to update you on the latest update of the Dalbar QAIB Study.  It’s possible that you might see yourself in these statistics.  After that, I’m going to discuss the original conclusion reached in the QAIB Study, and why we chose a different track when developing our AdvisorLink® Program

    First, however, I’m going to briefly discuss the 3Q GDP report that came out last week after my weekly E-Letter had been published.  To say the least, the number surprised most analysts by coming in on the high side of economists’ forecasts.  I think you’ll find both subjects to be very interesting reading, so let’s get started.

    Third Quarter GDP Surprises on the Upside

    Last Thursday, the Commerce Department reported that 3Q GDP rose 3.5% (annual rate).  This was above pre-report estimates which averaged around 3%. The government noted that the rebound in the 3Q was led by increased consumer spending (think "cash for clunkers"), higher exports and a continued increase in federal spending.

    Most analysts concluded that the better than expected 3Q GDP report confirms that the US economy came out of the recession in the July-September quarter.  However, the Consumer Confidence Index unexpectedly fell sharply in October, partly due to the continued rise in unemployment, which raises questions about economic growth in the 4Q.

    Finally, keep in mind that the 3Q GDP report will be revised two more times in the coming weeks, and it will not surprise me if it is revised downward, what with the unemployment rate on track to top 10% by the end of the year.  And for most of us, this economy does not feel like it's growing at the rate of 3.5%.

    Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
    are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

    Why Do Investors’ Returns Trail the Market?

    Before going into the most recent update of the Dalbar QAIB study, it is probably worthwhile to provide some background on exactly how investor returns and fund returns can differ.  I would bet that many readers just assume that investors always earn returns in line with those of the equity and bond mutual funds they hold, but this is definitely not always the case.

    In a nutshell, fund returns represent what someone buying and holding a particular mutual fund would have earned over a specific time period.  Returns for the “average investor,” on the other hand, factor in behavioral measures that can (and do) affect the actual returns earned by investors in these funds.  Dalbar explains it this way:

    “…the [QAIB] study utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior.  These behaviors are then used to simulate the ‘average investor.’  Based on this behavior, the analysis calculates ‘average investor return’ …”

    In other words, switching among investments has an effect on the eventual return received, both on a long-term and short-term basis.  Dalbar and others have found that investors who tend to hop from one hot mutual fund to another not only fail to enhance their performance over industry benchmarks, but have been shown to actually end up earning a far smaller return because of their periodic switching among funds. 

    Why do investors hop from fund to fund so much?  The reasons vary, but my experience has been that some investors panic when losses occur and get out of the market.  Others frequently change their investments to chase the hottest returns.  Unfortunately, this hot performance mindset is aided by financial publications that routinely list the top five or 10 or 20 best funds for the previous year.  Investors often look at their own return during the year compared with the “hot” funds, and decide to switch and get in on some of that high-powered performance.

    Unfortunately, the mass migration of investors to funds with the best previous performance often guarantees that those funds will not repeat as a top performer the next year.  The end result is that funds with hot performance one year often lag behind other funds in subsequent years.  Thus, those investors who flocked into these funds after their best performance often find that they would have been better off had they stayed in their old funds.

    So, do investors learn their lesson and look for funds with consistent long-term performance?  The answer for many of them is “no,” and they continue hopping to the next hot fund and hoping for a repeat performance that seldom happens.  This is what we like to call becoming a “Dalbar statistic.”

    The 2009 QAIB Study Update

    The 2009 update of the original QAIB Study measures performance over the 20-year period extending from January 1, 1989 through December 31, 2008.  Considering that this period includes both the 2000 – 2002 and 2007 – 2008 bear markets, one might conclude that investors who frequently switch among mutual funds on their own might have had better results than those of the actual mutual funds, but you’d be wrong.

    Here’s what the most recent update to the Dalbar QAIB Study found:

    1. Over the 20 years ending December 31, 2008, equity mutual fund investors had average annual returns of only +1.87% while the S&P 500 Index averaged +8. 35% over the same time period.
    2. Fixed income fund investors had average annual returns of +0.77% over the same 20-year period, while the benchmark Barclays Aggregate Bond Index averaged +7.43%.
    3. Note that both the equity and fixed income fund investors’ average returns were less than inflation, which clocked in at 2.89% over this 20-year period of time.
    4. Confirming the “lost decade” concept, Dalbar’s study showed that the S&P 500 Index had negative returns over 10, 5, 3 and 1-year time windows.  Fixed income investors, however, fared better with the Barclay’s Aggregate Bond Index averaging positive returns ranging from +4.65% to +5.63% over this period of time.  However, neither the average equity fund investor nor average bond fund investor beat the benchmark returns over any of the 1 to 10-year time windows. 

    Thus, the QAIB Study again shows that investors’ own behavior is detrimental to their long-term investment goals.  Following are graphic representations of the study’s findings.  The first graph shows the performance of the various benchmarks used in the QAIB Study during various time windows:

     Benchmarks as of 12/31/08

    The next graph shows the performance of the average equity, fixed income and asset allocation mutual fund investor over the same time windows:

     Investor Returns as of 12/31/08

    To sum it all up, many mutual fund investors have been their own worst enemies over the last 20 years.  The only bright spot, if you can call it that, was a statistic showing that the average asset allocation fund investor fared better than both the S&P 500 Index benchmark and average equity fund investors in 2008, losing “only” 30%.  In fact, the average asset allocation investor lost less than the average equity fund investor in most time periods.  Obviously, this is a function of having both equity and fixed income mutual funds in the typical asset allocation portfolio.

    However, something even more interesting is that asset allocation did not enhance performance over the long haul.  Note that the average asset allocation investor had an average annual gain of only 1.67% over 20 years, versus 1.87% for the average equity mutual fund investor.

    News Flash – Investors Panic in Down Markets!

    Another, rather obvious finding in this year’s QAIB Study update was the fact that “When the going gets tough, investors panic.”  In all previous updates of the QAIB Study, Dalbar has pointed out that investors’ emotional behavior can significantly affect their returns.  However, their advice has been to simply suppress this emotional behavior and stay in the market.

    This advice tends to ring hollow in bear markets like we had in 2000 – 2002 and 2007 – 2009.  It’s like being on the Titanic and Dalbar saying “please remain calm and proceed in an orderly fashion to the lifeboats.”  Some may heed the call, but the average passenger, like the average investor, is likely going to panic.

    Thus, Dalbar has finally realized that investors engage in irrational behavior despite scholarly advice to the contrary.  To illustrate this behavior, Dalbar has developed a “Guess Right Ratio” that measures how often the average equity fund investor makes an accurate investment decision based on the market environment.  In other words, this ratio measures how often the average investor buys low and sells high.  Over the 20-year period covered in the study, Dalbar found that “Market declines caused panic and panic led to bad decisions.  And bad decisions combined with declining markets resulted in exacerbated losses.”

    What I find disappointing in all of this is why it took Dalbar so long to figure out that investors won’t necessarily heed a call to ignore losses and stay invested during bear markets and major corrections.  When I read the first QAIB Study back in 1995, my initial reaction was that investors need professional management because they were not likely to have the discipline to remain invested in losing markets, no matter how many times their broker tells them to “stay the course.”  After only 15 years, Dalbar finally sees the light.

    A Chink in Passive Investing’s Armor?

    Perhaps the most surprising revelation in the 2009 QAIB update compared to all previous years is that traditional passive buy-and-hold strategies are not seen as a solution to the problem.  Not only did Dalbar decide against endorsing traditional asset allocation as a solution, they actually came to the realization that such strategies don’t work.  Here’s how Dalbar put it in this year’s update:

    “This year’s report … also demonstrates that simply adopting a one-size-fits-all asset allocation strategy will not suffice in the new investment paradigm.” [Dalbar QAIB, Page 2]  “Portfolio performance during the market meltdown of 2008 is clear evidence that the current methods are ineffective, even independent of investor behavior.  Current asset allocation and diversifi-cation strategies are based on uncorrelated asset classes that in 2008 became highly correlated, thus rendering all such strategies moot.” [Dalbar QAIB, Page 11, Emphasis added]

    For a while, I thought that Dalbar may have been reading my E-Letters.  After all, I have been making similar observations about buy-and-hold strategies for a very long time.  However, I soon learned that they are not running plays from my playbook when I began reading their new recommendations to help investors keep from being their own worst enemies.

    While space does not permit me to go into detail about each of Dalbar’s recommended solutions to inferior investment returns, I’ll discuss each of them briefly below:

    1. Dalbar’s first suggestion to help investors get better returns was to consider using Dollar Cost Averaging (DCA) to ease back into the market.  I have written about DCA in the past in the E-Letter, and it is essentially a method of investing where you gradually invest your portfolio in increments over time.  This means that you buy into the market at different price levels and are somewhat less susceptible to a major market downturn.  In fact, investing during these market downturns can result in buying at bargain prices, which should be good for your portfolio in the long run.

    Of course, this only works if you have moved your money to the sidelines or are making periodic contributions to a retirement plan.  I think that DCA can be a good idea if you are in a 401(k) or other type of plan where you have only mutual fund options and cannot access actively managed investment strategies.  Obviously, this technique is not available for anyone who is already fully invested in the market.  For those investors, Dalbar had other alternatives as discussed below.

    2. The second strategy that Dalbar suggested was to consider a portfolio management technique known as Purpose-Based Asset Management, or PBAM.  This strategy has the benefit of being available to both investors on the sidelines and those already fully invested.  That’s the good news.  The bad news is that this approach is little more than buy-and-hold “lite.”

    According to Dalbar, traditional asset allocation strategies often assume only one level of risk tolerance for the entire portfolio.  The main premise behind PBAM is that investors actually have multiple risk tolerances depending upon the particular investment goal.  Investors may be more comfortable with higher risk on investments held for longer periods, such as for retirement, than they are for investments held for shorter-term goals. 

    Thus, investors are encouraged to allocate assets into separate strategic “compartments” based on the ultimate goal for that part of the portfolio, and then design an asset allocation strategy based on the appropriate risk level for each compartment.  The hope is that money allocated more conservatively will lose less in down markets than the more aggressive compartments, resulting in less panic on the part of the investor.

    In reality, this simply means that instead of having one big asset allocation portfolio, they will have multiple small buy-and-hold portfolios that will be subject to the same limitations as any other passive asset allocation strategy.  My personal opinion is that PBAM is simply a marketing gimmick that will result in little difference in overall performance or emotional decision making.

    3. A final recommendation from the Dalbar report is to explore the use of leverage within portfolio holdings, both at the portfolio and individual holding level.  In essence, Dalbar is acknowledging that leverage, especially in the credit markets, played a big part in the subprime meltdown and resulting credit crisis. 

    Since this leverage can occur in the private sector, government and international markets, Dalbar suggests that investment experts begin requiring issuers of securities to compute and disclose their true leverage.  Once disclosed, Dalbar suggests that leverage should be incorporated into computer models that screen investments as well as asset allocation models. 

    Same Study, Very Different Conclusions

    While the conclusion reached by this most recent update of the QAIB Study pretends to offer a new approach to investing, it’s really just a tweak of traditional buy-and-hold.  This really isn’t all that different than the findings in prior years when Dalbar recommended investors follow buy-and-hold strategies and suppress the emotional desire to exit mutual fund investments when (not if) they begin to lose money.

    I noted above that the Dalbar and Zweig studies were the catalyst for the development of my firm’s AdvisorLink® Program.  Yet, AdvisorLink® is anything but a buy-and-hold investment program, so how did we get from Dalbar’s recommendation to an innovative collection of active management strategies?

    It happened this way:  I reported the findings of these studies in my monthly client newsletter (remember when publications were actually printed on paper?), but pretty much dismissed its applicability to my audience since most were experienced investors in my managed futures funds.  Anyone sophisticated enough to invest in futures funds must be able to handle their own mutual fund investments, right?

    Wrong!  Imagine my surprise when a very large percentage of my futures funds’ investors responded to my newsletter saying that the Dalbar QAIB Study described their own behavior.  They resoundingly supported our research into a way to keep from becoming a “Dalbar statistic.”

    We then had to develop a strategy to try to get investors to avoid emotional decisions in down markets.  While Dalbar suggested just saying “no” to switching among funds, we knew that investor psychology would dictate moving away from equities when the pain became too great.  As a result, we took a different track in addressing investor psychology.

    First, we reasoned that investors who are doing everything on their own were becoming confused with all of the conflicting information in the marketplace.  We called this “information overload,” and this was just the early days of the Internet.  Thus, our first principle was that investors should seek out the help of professional money managers rather than trying to do everything themselves.  This helps take some of the emotion out of the equation, since a third party is responsible for investment decisions.  This first principle was the genesis of our AdvisorLink® name, since we were linking investors to qualified Investment Advisors.

    The next principle we adopted was that all of the strategies in our AdvisorLink® Program had to be actively managed.  We saw no benefit in strategies that would stay fully invested in the face of a bear market or major correction.  It just makes sense to move to cash or hedge long positions when the markets are going against you.  This, too, helped to reduce the emotional impulse to sell during bad markets.  We even included more aggressive programs that were able to “short” the market with the potential to actually make money during down markets.

    A final principle in the establishment of our AdvisorLink® Program was that it needed to be mutual fund based.  While we were aware of active money managers using individual stocks and bonds, many had minimum investments in the hundreds of thousands of dollars, and some required over a million.  By concentrating on Advisors who used mutual funds, we were able to bring the advantage of professional money management to our clients at reasonable minimum investment levels.

    Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
    are not affiliated with nor do they endorse, sponsor or recommend the following product or service.


    The Dalbar QAIB Study has been a valuable tool in educating both investors and Advisors about the dangers of emotional trading.  While QAIB is instructive in showing weaknesses of the average investor’s actions, it falls short on solutions.  I predict that you’ll be hearing more about Purpose-Based Asset Management in the future as this marketing gimmick catches on with brokers who want their asset allocation programs to sound like something other than what they are.  Just remember that PBAM is nothing more than buy-and-hold lite.

    The purpose of my short history lesson about our AdvisorLink® Program is to give you some insight as to why it is structured the way it is and why we feel it’s important to have active management represented in your portfolio.  These strategies not only address the issue of investor panic and emotional trading, but also offer additional strategic diversification over buy-and-hold. 

    If you would like more information about AdvisorLink® or the various strategies offered within that program, you can learn more by going to our website at www.halbertwealth.com.  Or, feel free to give one of our Investment Consultants a call at 800-348-3601.  I think you’ll be glad you did.

    Very best regards,

    Gary D. Halbert


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    "Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc. are not affiliated with nor do they endorse, sponsor or recommend any product or service advertised herein, unless otherwise specifically noted."

    Forecasts & Trends is published by ProFutures, Inc., and Gary D. Halbert is the editor of this publication. Information contained herein is taken from sources believed to be reliable, but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgment of Gary D. Halbert and may change at any time without written notice, and ProFutures assumes no duty to update you regarding any changes. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Any references to products offered by Halbert Wealth Management are not a solicitation for any investment. Such offer or solicitation can only be made by way of Halbert Wealth Management’s Form ADV Part II, complete disclosures regarding the product and otherwise in accordance with applicable securities laws. Readers are urged to check with their investment counselors and review all disclosures before making a decision to invest. This electronic newsletter does not constitute an offer of sales of any securities. Gary D. Halbert, ProFutures, Inc. and all affiliated companies, InvestorsInsight, their officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Securities trading is speculative and involves the potential loss of investment. Past results are not necessarily indicative of future results.

    Posted 11-03-2009 5:04 PM by Gary D. Halbert
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