By Bob Wood
Douglas â€œWrong Wayâ€ Corrigan might be a role model of sorts for modern investors; heâ€™s remembered for going in the wrong direction, flying from New York to Ireland instead of Long Beach, California, as planned. Another might be Roy Riegels, the University of California football player, who, during the 1929 Rose Bowl, recovered a fumble but ran to the wrong end zone. He pushed away teammates trying to correct his course. Investors, too, may spend considerable time running towards failure and away from the goals that really work over time.
Of course, Iâ€™m not referring to any of you. I know that weâ€™re all above-average investors who beat the market, year after year, right? At least thatâ€™s how the stories go. But someone actually had the nerve to look at investorsâ€™ long-term performance and found that winning the loserâ€™s game of investing is truly a rare feat.
Mutual fund consultant Dalbar has again updated its research to show actual returns achieved by individual investors. We already know that most professionals, mutual fund managers in particular, do not beat their proper benchmarks over extended time. Now we also know that individuals rarely do either and, for the most part, would be far richer had they avoided the stock markets altogether. And to be fair, I donâ€™t know enough about the study to know how often a broker or other advisor was involved here, so maybe the individual investor get some benefit of the doubt.
I first learned about Dalbar studies while reading the investing classic, Winning the Loserâ€™s Game, by Charles Ellis. In the book, Ellis points out how, during most of the long-running bull market of the 1980s and 1990s, the average stock market investor earned about half the annual returns posted by the stock market, as represented by the S&P 500, and about half the earnings of the average mutual fund, as well.
The Dalbar work, involving the period ending in 1995, shows clearly that, on a risk-adjusted basis, individuals would have done better invested in bonds or real estate and completely avoiding one of the great bull markets of their time. So do you think investors have learned the lessons of how and why they repeatedly failed to achieve a fair return for the risks taken in stocks?
On the other hand, have you ever heard of Dalbar or read Ellisâ€™ book on investing?
Apparently not many have, considering what Dalbar people found in their most recent work. A short article in a recent issue of Financial Times says, â€œAn average investor in equity mutual funds received an annualized return of only 3.9% over the 20 years to the end of 2005â€”compared with an annual return of 11.9% for the Standard and Poorâ€™s 500 index…â€™â€™
Wow, really?! Investor performance actually worsened when compared to an earlier time period covered by Ellis and Dalbar. An annual return averaging less than 4% must be a shock to any investor. That 4% comes during an inflationary environment when the dollar has lost about half its purchasing power. Where are the risk premiums? And how is it, with the advent of CNBC, Money Magazine and more brokers than anyone really needs, that so many investors would have fared better financially if they had never bought their first share of stock or a mutual fund?
Are Jeremy Siegelâ€™s â€œstocks for the long runâ€ clearly meaningless in the real world? So what happened? How many â€œwrong way investorsâ€ fared so poorly during times with such strong returns?
According to Dalbar, â€œthe difference was due almost entirely to investors moving their money into and out of funds at precisely the wrong moment. The study contends that investor behavior is just as important as market performance in determining the returns actually received.â€
So just as â€œWrong Way Corriganâ€ and â€œWrong Way Riegels,â€ investors have made the directional mistakes themselves! No one made them go the way opposite to the one that would have brought success. No one makes investors plow into tech stocks like JDS Uniphase at $150/share and hold it all the way down to $3, thinking the whole time that the stock was just too cheap to give up on.
More recently, investors have sent record amounts of money into emerging markets, gold and commodity funds. And, yes, I have been happily involved in those areas for the past three to five years myself. But as with most winners in the investing game, when the crowd piles in, the end is usually near. So during late May and early June, those asset classes have seen some nasty selling. How many investors who got into them late have been spooked by rapid declines in those markets or commodities like gold?
Yet some good news the Dalbar people found shows that, in the past three years, investor performance has risen to something akin to respectability. And what was the main factor in this improvement? The Dalbar folks think it involves investor patience, a rare and welcome trait! Investors have been holding on to their mutual fund shares for an average of 4.3 years, the longest holding term of the past 20 years. Of course, this could relate to the three-year bull market cycle not yet ending, to most.
But what now? Given the increased volatility and sometimes scary drops in the more popular international indices, will investors remain patient? Thatâ€™s hard to determine now, of course, but thatâ€™s a concern. What about you? What will you do in the face of rising uncertainty? Or for that matter, what will I be doing?
For me, itâ€™s an easy call. During the past few months, I have reduced allocations on the long side of my managed accounts and used the cash raised to grow my hedges in the form of bear market mutual funds or short sales of individual stocks. Yet I remain invested in what I think are the best values to be found. And since long-term, secular bull markets are what I look forâ€”and stay with when I find them, I see little reason to sell what I think will be the best performers, regardless of short-term and admittedly disconcerting down drafts.
Iâ€™m much more concerned about the future prices of my long-side holdings in another five, 10 or 20 years from now, as opposed to so many hedge fund and mutual fund managers trying so hard to protect this quarterâ€™s performance numbers.
While prices of some of my favorite stocks and funds have dropped in recent weeks, I think the value of these holdings has remained the same or, in some cases, has risenâ€”while the share price has fallen. Yes, prices have fallen, but values have not. How concerned should I be that Conoco Philips stock prices have fallen from $72 to $60 in less than two months or shares in Petrobras have dropped from over $100 down to $79?
Both companies sport single-digit price to earnings multiples, and business is booming, fed by demand the world has never seen with the emergence of almost half the worldâ€™s population into the capitalist mainstream. Or how about another favorite, CVRD, which just announced another price hike of 19% atop the 71% increase in iron ore prices gained last yearâ€”all fueled by demand for its exports that surprised even the company? And these shares are valued at less than 10 times 2006 earnings. Why should I sell it? Yet others certainly are selling.
While the price of gold has fallen dramatically, from about $740 an ounce down to just over $600, the fundamentals for gold have never been so good. In fact, I think that just five or 10 years ago, no one, not even the most dedicated gold bug, would have been daring enough to state publicly that goldâ€™s fundamentals would become so goodâ€”with money printing and inflation figures soaring into the ether. But recently, gold, both the metal and shares of funds and stocks in the sector, have been pounded into the dirt.
I havenâ€™t sold and wonâ€™t sell any of these for a very long time. But thatâ€™s just my thinking! When I finally find one of those stellar, secular, long-term bull markets somewhere, I hang in there for dear life. It only takes one or two of these wonderful trends to make investors laugh at the seemingly pedestrian returns to be earned going forward by most, using the S&P 500 or any other proxy like the Dow.
Patience is the key, after, of course, identifying the right trends to follow. But changing your mind about which fund to buy every few months is a recipe for financial disappointmentâ€”to the tune of 3.9% annually and well under the current rate of inflation. Find the trends that you can ride comfortably, through the inevitable ups and downs. Success in investing is a matter of time, not timing. And never has there been a wonderful, secular bull marketâ€”in anythingâ€”that went straight up.
And turn off that useless noise on CNBC! The promoters with all those wonderful titles and associations with big brokers offer advice that more often than not has done nothing at all for investors. â€œBuy this, sell that, trade this, use this chart…whatever.â€ These Perma-Bulls offer hope, and, like Jeremy Siegel, assure you that they share the secrets of generating wealth in stocks. I wonder what excuse they have for the Dalbar findings?
But do not, of course, listen to those worrisome Bears! What do those fools know, anyway?
â€œWhat all the wise men promised has not happened, and what all the damned fools said would happen has come to pass.â€
â€”Lord Melbourne, former British Prime Minister
Have a great week,