The Cost of Impatience
Buy and hold is still the exception to the rule
Do not use near open flames. Do not overinflate. Discard if seal is broken.
Many consumer goods carry disclaimers or instructions that help us get better performance from the product. According to an annual study of mutual fund returns, it might make sense to apply the following instruction to the front cover of mutual fund prospectuses in big red capital letters: "Do not panic and sell.”
The Quantitative Analysis of Investor Behavior study published by Dalbar compares the actual investment returns achieved by investors against a simple buy and hold strategy. Dalbar reports that over the last 20 years, a buy and hold strategy has delivered far better returns than the average investor has earned.
For the 20-year period 1990-2009 (a span that included, among other events, the dot com bubble, 9/11, and the mortgage meltdown) the benchmark S&P 500 index generated a respectable annualized return of 8.20 percent. Meanwhile the average return earned by equity fund investors over the same time frame was just 3.17 percent, barely beating the annualized inflation rate of 2.80 percent.1
Investors in fixed income funds suffered the same fate, earning an average annualized return of just 1.02 percent over the last 20 years, far less than the benchmark, Barclay’s Aggregate Bond Index (7.01 percent).2
Investors are impatient
Earning the benchmark return, or even something close to it, required nothing more than buying and holding a broad index fund. So why the big shortfall? Dalbar’s answer is simple: “Investors are impatient…and irrational.”3 Instead of buying and holding, the average investor buys, watches CNBC, worries, second guesses, sells, worries about being on the sidelines, and buys something else.
Buy and hold is clearly the exception, not the rule. Over the last 20 years the average retention periods for equity and fixed income mutual funds have been just 3.22 and 3.21 years, respectively.4 This jumping in and out of the market and from fund to fund may give the investor a sense of control, but the impact on return is clear – on average, buy and hold has yielded better outcomes. The average investor, the study indicates, buys high and sells low often enough to severely erode long-term return.
So easy to sell
Even for investors intending to buy and hold for the long term, the temptation to try to time the market can be irresistible. Almost any stimulus – from fear of the unknown to fear of the known – can lead to a quick, misinformed, or irrational decision. Common triggers to sell or to jump from one fund to another include:
- Disappointing short-term performance
- Market volatility
- Negative economic reports or forecasts
- Positive economic reports or forecasts
- Aggressive marketing by other funds
- Recommendations of analysts or commission-driven broker/dealers
- Hot tips from friends and colleagues
- An urge to take profits
- An exaggerated confidence in one’s ability to pick winners
Buying is not the only risk
Every mutual fund is required by the SEC to provide a prospectus that describes the fund's investment objectives or goals, its strategies for achieving those goals, the principal risks of investing in the fund, the fund’s fees and expenses, and its past performance. Advertisements, newsletters and other communication from mutual fund companies carry additional disclaimers about risks.
Taken as a whole, the disclaimers and cautions provided in mutual fund literature describe the dangers of buying and owning a fund. Based on the Dalbar study, it may be just as important to understand the risks of selling.
Bright Sky Group advisors will help you create a long-term plan that does not rely on guessing how the market will perform in the short term. Instead of trying to time the market, we advocate a patient, unemotional approach: allocate assets to balance risk and return, buy-and-hold, rebalance in good times and bad, and take advantage of what the market offers.
2 Ibid.
3 Ibid.
4 Ibid.
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