Research Affiliates co-founder Jason Hsu along with fellow finance professors Brett Myers and Ryan Whitby carried out a study of value funds in 2015 that shows investors pile into hot funds when they’re hot and pile out of cold funds when they’re cold producing long-term returns that are significantly lower than if they’d simply bought once and then forgot about them.
Looking at value stocks over a 13-year period between January 1991 and June 2003, the trio of professors found that buy-and-hold investors earned annual returns of 9.36% compared to 8.97% for the S&P 500 while dollar-weighted investors managed only 8.05%.
Advisors and finance professionals refer to this as the “behavioural return gap” and it’s a big reason why many investors are better off utilizing a financial professional with the experience to screen out the daily noise of the financial media.
“Can you and your stomach tolerate the dizzying highs and the abyss-like depths of the stock market indices over a lifetime of investing?” asked Assante Financial Management Ltd. advisor Glenn Szlagowski referring to the typical bombardment of news the average investor is subjected to. “The news media have no trouble whatsoever telling you when or what to buy, when to sell and that the coming Apocalypse is surely just around the corner.”
Investors have become hyper-sensitive to any bit of bad news with good reason – 2008 wasn’t fun for anyone, advisors included.
“The big debate with some journalists and investor advocates is that the cost of the investments always trumps behavioral economics,” suggested Szlagowski. “Behavioral economics in a nutshell, is the study of what real investors do in the real world and what motivates investors to make rational or irrational decisions with respect to their investments. In the real world, investors get investor returns, not investment returns – a very big distinction indeed.”
The evidence continues to highlight just how irrational most investors can be and how advisors earn their keep.
“Bottom line, the prime determinant of investor success is what they do with their investments after they bought them and that is where advisors earn their fees by modifying or tempering bad investment behaviors during key inflection points,” said Szlagowski.
While Szlagowski uses mutual funds the same opinion is heard from advisors using ETFs to construct their client portfolios.
“Advisors can add value, not by picking stocks or picking funds, but by encouraging investors to engage in ‘constructive behaviour modification’,” said John De Goey, a portfolio manager with Burgeonvest Bick Securities Ltd. “In other words, people who work with (good) advisors are thought to be less likely to engage in the self-destructive behaviour referenced in this study.”