Mutual Funds And Why Most Investors Consistently Underperform The Market

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by Gary D. Halbert

May 5, 2015


  1. Dalbar Studies – Why Investors Make Less than the Market
  2. Most Investors Are Not Good at Managing Money
  3. The Benefits of Professional Active Management
  4. Niemann Capital Management Has Beaten Market With Less Risk

Dalbar Studies – Why Investors Make Less than the Market

Long-time clients and readers will recall that for years I have been writing about the annual Dalbar Studies which compare the actual performance of mutual funds versus what the average mutual fund investor actually earns. You may also recall that the numbers are quite ugly – the average investor makes significantly less than mutual fund performance reports would suggest in both stock and bond funds.


The problem is not that mutual funds overstate their performance. The problem is that too many investors decide to switch into and out of mutual funds too frequently, in the hopes of boosting their returns. All too often, investors decide to sell the fund(s) they currently own, often at a low point, and switch into the latest hot performers, just before they hit a losing period. This practice too often results in selling low and buying high. I call it the “Mutual Fund Merry Go-Round.”

Dalbar tracks the actual returns earned by investors by analyzing mutual fund purchases and redemptions throughout the year. So, let’s look at the Dalbar numbers for 2014 and for the last 20 years on average:

  • In 2014, the average equity mutual fund investor underperformed the S&P 500 by a wide margin of 8.19%. The broader market return was more than double the average equity mutual fund investor’s return – 13.69% vs. 5.50%.
  • As of 2014, the 20-year annualized S&P 500 return was 9.85% while the 20-year annualized return for the average equity mutual fund investor was only 5.19%, a gap of 4.66%.
  • In 2014, the average fixed-income mutual fund investor underperformed the Barclays Aggregate Bond Index by a margin of 4.81%. The broader bond market returned over five times that of the average fixed income mutual fund investor – 5.97% vs. 1.16%.
  • As of 2014, the 20-year annualized Barclays Aggregate Bond Index return was 6.20% while the 20-year annualized return for the average fixed income mutual fund investor was only 0.80%, a gap of 5.40%.

In summary, the average equity investor underperformed the S&P 500 by a gap of 8.19% in 2014 and an average annual deficit of 4.66% over the last 20 years. The average fixed-income (bond) investor underperformed the Barclays Aggregate Bond Index by 4.81% in 2014 and an average annual deficit of 5.40% over the last 20 years.

If you have not seen these Dalbar statistics before, you are probably shocked. So was I when I first saw them in 1994! What is most surprising is that there has been very little improvement in the numbers over the last 20 years.

Most Investors Are Not Good at Managing Money

After decades of analyzing investor behavior in good times and bad, and after enormous efforts by industry experts to educate millions of investors, bad decisions continue to be widespread. When discussing investor behavior, it is helpful to first understand the thoughts and actions that lead to poor decision-making.

Investor behavior is not simply buying and selling at the wrong times; it is the psychological traps, triggers and misconceptions that cause investors to act irrationally. It is that irrationality which leads to the buying and selling at the wrong times, which leads to underperformance. Put differently, many investors are their own worst enemy when it comes to investing.

As a result of these findings from Dalbar and other market research groups, there is a widespread belief, not only among most investors but also among many industry professionals, that it is nearly impossible to beat the market. But that is simply not true, as I will demonstrate below.

While many retail investors, and even many professional investors, are not very good at making investment decisions, there are some Registered Investment Advisors (RIAs) and other professionals that have been successfully investing in the markets for years.

Most successful RIAs (and other successful traders) use proprietary software that they have developed internally. Some use complicated algorithms that determine whether to be in the markets, or on the sidelines in the safety of cash. Many rely on multiple indicators within one strategy.

Most of these actively-managed systems are designed to be in the markets (long) most of the time. However, at certain points, based on various risk measurements, the system may signal that risks outweigh any possible return potential. Systems vary widely of course and some may move only partially to cash, while others may be 100% in cash until market conditions improve.

The Benefits of Professional Active Management

Before I begin this section, let me state for the record that many active management systems, including some that are managed by professionals, don’t work. Since we founded Halbert Wealth Management (HWM) in 1995, we have looked at hundreds and hundreds of active managers, and I would venture that over 90% either weren’t successful or didn’t meet our rigorous standards.

However, there are some very successful active managers in the industry. Unfortunately, most investors don’t know how to find them. Fortunately, at HWM we know how to find and evaluate them, and we have the resources to continually look for them all across the country.

With that said, let’s move on to the benefits of active management. The first goal of any actively-managed strategy is to reduce risk. Moving partially or fully out of the market may allow one to miss some of the large downward movements and bear markets.

I have reprinted this table many times over the years. It illustrates very clearly why it is so important to avoid big losses in the markets.

If you lose 20%, you must make 25% just to get back to breakeven. Lose 30% and you must make almost 43% to recover to even. Lose 40% and you have to make over 66% just to get back to breakeven. Lose 50%, as the S&P 500 did from late 2007 to early 2009, and you must make 100% to get back to breakeven.

As we all know, it took six years for the S&P 500 to recover to where it was when the financial crisis hit in late 2007!

The main problem with the traditional “buy-and-hold” strategy is that it subjects investors to very large losses from time to time. Sharp downward “corrections” occur fairly frequently, and we experience a serious bear market now and then. Most investors believe when they start out that they can be patient and hold on through these sometimes terrifying downturns.

Yet millions of investors panicked in 2008 and early 2009 and bailed out of the market, in many cases with huge losses. Most retirement accounts were devastated. As noted above, the S&P 500 Index plunged by more than 50% from late 2007 to the bottom in March 2009. Many investors vowed to never again put their money in stocks and have never gotten back in.

Investors Mutual Funds

Sadly, they missed the historic bull market that has unfolded since then.

Again, the primary goal of a successful active management strategy is to avoid some of those losses by moving partially or fully to cash (money market) and awaiting the next signal that the downturn is over before going back into the market.

In addition to missing the big downturns in the market, it is equally important to know when to get back in. It is just as important to catch most of the “up” days in the market. So active-management is all about knowing when to get out and when to get back in. Successful active-management strategies can do both. Here is an example for today’s discussion.

Niemann Capital Management Has Beaten Market With Less Risk

There are currently 11 professional active managers on our recommended list at Halbert Wealth Management, Inc. Most of our recommended managers invest in equities directly or via stock mutual funds and increasingly Exchange-Traded Funds (ETFs). In addition, we also have active managers that invest in bonds, including convertible bonds – which sadly most investors do not have in their portfolios (because they don’t understand them).

For today’s discussion, I have selected Niemann Capital Management which we have recommended continuously since 2001. Niemann offers multiple strategies but the one we recommend for most clients is called the “Risk Managed Program” which began investing in late 1996. Since its inception, Risk Managed’s annualized return has handily outperformed the S&P 500 Index with about half of the downside risk (as measured by drawdown).

Risk Managed’s objective is to exploit intermediate stock market trends while also seeking to limit risk. The strategy identifies those sectors of the market that are gaining momentum and invests in those areas using domestic equity ETFs.

Risk Managed typically holds 10 to 15 positions representing a broad universe of ETFs that Niemann’s proprietary strategy has determined to have the highest potential for gain. In downward trending markets, Risk Managed will move partially or fully to cash (money market), awaiting another uptrend. Risk Managed can be fully invested, partially in cash, completely in cash, or even partially short as a hedge against existing long positions. It will not go net short.

So, let’s take a look at the actual performance that Niemann’s Risk Managed Program has delivered over the last 18 years. It is important to note that all results shown below are NET of all fees and expenses, including management fees.

Investors Mutual Funds

Investors Mutual Funds

As you can see, Niemann’s Risk Managed Program has clearly beaten the S&P 500 since its inception. Best of all, Risk Managed (as its name implies) has delivered these returns with much less risk than if you had owned the S&P 500 Index, which plunged over 50% during the Great Recession.

How do we know the numbers shown above are real? They are compiled using rigorous industry standards and because I have my own money invested, which allows us to monitor performance on a daily basis. And as a reminder, the numbers above are net after fees and expenses.

CLICK HERE for more details on Niemann’s Risk Managed Program. As always, past performance is not necessarily indicative of future results. Be sure to read Important Notes and disclosures at the end.

The minimum investment for Risk Managed is only $50,000. Niemann also has another program that is similar to Risk Managed but also invests in bond and international funds – in case you are looking for offshore exposure. That program is the Niemann Global Opportunity Strategy.

Getting Started is Easy – Here’s How It Works

To invest in Niemann’s Risk Managed Program, you simply need to contact us (see below) and we will send you the forms to open an account at Fidelity Brokerage and give Niemann authority to make the investments in ETFs in your account.

You have complete transparency since you can monitor activity in your account daily (if you wish) on Fidelity’s website. You can also add to or close your account at any time as there is no lockup period.

In closing, I am very confident that many of you reading this would benefit from having a portion of your money in an actively managed account with Niemann Capital Management, and specifically in its Risk Managed Program. And remember that I have my own money invested with every money manager that we recommend.

If you have been reading me for years but have never become a client, I invite you to join us today. Please feel free to contact us in any of the following ways:

Best regards,

Gary D. Halbert


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