March 3, 2010

Study: Average investors often trail average fund performance

Newly published data (PDF) from Morningstar reveal the fund categories in which the average investor is trailing average fund performance. For example, large-cap growth funds: Morningstar found that over the three years ending 12/31/2009, the average fund in that class lost 2.9%, yet the average investor in large-cap growth funds lost 3.6%.

Likewise, over the past three years average investors underperformed overall returns for mid-cap growth, large value, and mid-cap value funds, and also fell behind the average fund performance in sectors such as natural resources, utilities, and heath-care funds. (On the other side, average investors did better than average fund performance in small-cap growth and small-cap value funds.)

Morningstar's Russel Kinnel explains what's behind the numbers:

The gap between investor returns and total returns shows...how well investors timed their purchases and sales. (For all the details on the calculation, you can check out the two-page fact sheet here or the 10-page methodology document here.)...
A couple of years ago, doing this revealed that the average investor often did better than the average fund because, while their timing was off, they often picked bigger lower-cost funds. However, the whipsaw of the past two years has meant that, in most categories and in the aggregate, investors have done worse than the average fund....

The grand total for the average investor in all funds in the [period from 2000-2009] was a 1.68% annualized return, compared with 3.18% for the average fund.... In U.S. equities, the average investor earned a scant 0.22% annualized, compared with 1.59% for the average fund.

All that is interesting, but just how are investors supposed to do a better job of "tim[ing] their purchases and sales"? Only in hindsight can an investor see that it would have been wise to sell a particular fund earlier or hold it longer.

2010/feb/level4_table1.gif Trying to improve buy/sell timing decisions on a case-by-case basis, rather than simply following clearly defined decision-making parameters, is a good way to tie yourself in emotional knots!

This is why SMI's successful Upgrading strategy relies on non-emotional, mechanical signals for buying and selling. Upgrading works (as evidenced by the table at left) — and it's relatively easy on both the brain and the stomach!

Sure, once in awhile the mechanical signals mislead us. No system is perfect. But more often than not, the signals prove to be correct. That's why Upgrading has outperformed the market in 10 out of the past 11 years.