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Wednesday, October 3, 2012

DALBAR Results Questioned

Ever wonder how the individual investor does versus the market?  Everyone knows someone who made a killing investing.  More often these days, we hear of some maniac up the street who is day trading like crazy.  Ever wonder about your chances?  You ever think of going to the library, checking out 12 books on investing, burning the midnight oil reading them, and then going on CNBC to explain what a genius you are?

Apparently, a lot of people have and it has been going on for a long time.  How do I know?  I know because book stores have been supplied as long as I've frequented them with books that sell well and proclaim to have the secret for beating the market.

This question of whether Joe Blow is beating the market or not is actually a serious question in the investment community.  And it isn't that easy to answer.

One source that has been widely quoted and accepted is an annual study by DALBAR.  They find consistently that individuals underperform by 4% to 5% per year.  Get market returns, a calculator, and a bottle of wine, and spend some time seeing what this under-performance would do to a 20-year investment program; and it will hit you like a sledge hammer that under-performance of this magnitude is devastating!  In fact, you'll likely need another bottle of wine before you're done!

One key point to bring up is that the DALBAR study is expensive, and it is used by money managers to say "if you try to manage your own money, you'll probably screw up; so let us do it for you." (writer's note to self:  I'm not sure that last sentence reads correctly!)  More bluntly, there is an incentive on the part of DALBAR to come up with the kind of findings they report.

Sad to say, I'm in an industry where you have to keep your hand on your wallet and look into incentives at every turn.

A second key point is that it is difficult to decipher exactly DALBAR's methodology.  On seeing their results, any serious analysts would say "wow, I wonder how they got these results."  Good luck in figuring it out.

The relevance of all of this is neatly explained in a guest blog post at the Nerd's Eye View site by Harry Sit of The Finance Group.  The post, Does The DALBAR Study Grossly Overstate The Behavior Gap? examines the impact of the sequence of returns on investment performance and shows how it can produce highly misleading results.

I recommend the post highly - it is readable and you'll come away with a better understanding of investment returns.

Full disclosure:  I have referenced the DALBAR results myself when arguing that investors will do better by sticking to an asset allocation strategy to overcome the negative influence of emotions on the difficult task of successful investing.

1 comment:

  1. Quite a fascinating dissection I have to admit. Now I have to wonder every time I see 5 or 10 year performance of a fund!