Why Are Average Investor Returns So Poor?

Why Are Average Investor Returns So Poor?

Q&A With The Wall Street Journal’s Spencer Jakab by Lawrence Hamtil, Fortune Financial

Spencer Jakab is deputy editor of the Wall Street Journal’s Heard on the Street column, and is the author of a great new investment book, Heads I Win, Tails I Win: Why Smart Investors Fail and How to Tilt the Odds in Your FavorA former highly-regarded equity analyst and now a journalist at what I consider the premier business newspaper, Mr. Jakab has a wealth of experience in multiple facets of the financial industry.  

Mr. Jakab was kind enough to take time to elaborate further on some points he made in his book (which I highly recommend).  Below you will find a text version of our question and answer session.

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Q&A With Spencer Jakab

Lawrence Hamtil:  In your book, you cite a Dalbar study that says that poor investor behavior, – e.g. panic selling, or chasing returns, – costs investors perhaps as much as 2% annually (see JP Morgan graphic above), and one of your stated goals in writing the book is to try to get investors to improve their behavior, and thus their returns.  Despite the overwhelming evidence in your book, do you expect the majority of investors will still give in to emotion over reason?


Spencer Jakab:  I’m a realist and, unfortunately, my book can’t alter human nature. This is behavior that kept our ancestors in the gene pool through 99.9% of our existence as a species. But if I can get a decent number of readers to change their behavior to a small degree at the critical junctures that are most costly to them then it will earn those people many multiples of the book’s cover price.

Lawrence Hamtil:  You present a lot of evidence that show the costs of traditional mutual funds make them less than ideal vehicles for investment.  One is the total expenses of a typical mutual fund, which you state is about 2.27%; the other is behavioral, with actual investor returns of 6.9% annually lagging stated returns of 8.8%.  Because of this, do you think more efficient investing vehicles such as ETFs will continue to supplant mutual funds as the investment vehicles of choice?

Spencer Jakab:  In the past 40 years there has been a tremendous shift, particularly recently, in favor of low-cost active funds instead of higher-cost active ones. The trend has saved individual investors tens of billions of dollars annually. I wouldn’t write the obituary of active management yet, though. Many people still believe that there is sufficient investment skill out there to more than justify fees. But the low return world we live in may be hastening the shift. If you only get 6% a year and pay a quarter of it in away in expenses then you had better be pretty confident you’re getting something.

Lawrence Hamtil:  We offer clients the ability to exclude certain companies or sectors from their portfolios as they might object to owning them for moral reasons, but you consider excluding certain companies or sectors to be a mistake.  How should investors with moral objections view these companies and their role in their portfolios, then?

Spencer Jakab:   The way I explain it to people is that they aren’t actually withholding money from the company they exclude from their portfolio. The stock is bought or avoided in the secondary market. Potentially hurting your own returns to make a point is a little silly. Paying someone to do it through a fund compounds your error. If you object to, say, smoking, then use your pocketbook in a different way by giving to the American Lung Association.

Lawrence Hamtil:  One cost I have found that many investors ignore is the cost of taxes, and many seem to think (mistakenly) that they can’t be reduced or minimized.  What advice would you give to investors regarding making their portfolios more tax-efficient?

Spencer Jakab: That is an excellent point that I only touched on briefly in the book. Passive portfolios are far more tax-efficient than active ones. Furthermore, professional guidance can pay for itself through tax loss harvesting. The performance gap cited by Dalbar and others don’t even take the error of tax inefficiency into account.

The information provided above is obtained from publicly available sources and it is believed to be reliable. However, no representation or warranty is made as to its accuracy or completeness.

Lawrence Hamtil is a fourteen-year veteran of the financial services industry, having served clients in all aspects of the business during his career, which started in 2002. In 2005, he joined Dennis Wallace of Fortune Financial Services, LLC, becoming, at the time, one of Multi-Financial Securities, Inc’s youngest registered representatives. In 2008, Dennis and Lawrence made the decision to become fully independent by founding their own Registered Investment Advisory (RIA), Fortune Financial Advisors, LLC. He serves clients in the United States and Europe. His financial commentary has been referenced in Barron’s online edition.


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