These days, not too many people are singing the praises of their 401(k) plans. They have been called failures, with many having hidden fees and poor investment choices. But I was reading a Scott Burns article that had an different take on things: 401(k) plans are a miserable failure because most of us make bad choices.
Here the evidence: For the 20-year period from 1988-2007, the S&P 500 had annualized returns of 11.81%, while investment-grade bonds returned 7.56%. But what did the average mutual fund investor return? Only 4.48 percent. That’s worse than super-safe Treasury bills, which managed 4.53% annually!
This data is actually pulled from the “DALBAR study”, which I have seen referenced before. DALBAR is a research firm that provides research for financial professionals about investor behavior. Each year, they publish a report called the Quantitative Analysis of Investor Behavior where it compares the returns from average individual investors to various benchmarks. The news is not encouraging…
For years, mutual fund companies have been marketing their products using the long-term results of a lump-sum investment. The results typically show that the funds’ annualized returns have outpaced their designated benchmarks and inflation, implying that if investors purchase fund shares and hold them for similar time periods, they may achieve similar results.
Reality, however, is quite different from this scenario – and it’s not the fault of the fund companies. In this year’s Quantitative Analysis of Investor Behavior, DALBAR illustrates how investors are often their own worst enemies. By examining actual fund inflows and outflows during the 20-year period ended December 31, 2007, the analysis finds that investors often buy and sell at the worst possible times – and achieve commensurate returns.
As Burns quips, investors as a whole do seem have a great skill for “methodically buying equities when they were up and selling when they were down.” This sentence summarizes it best:
Investment return is far more dependent on investor behavior than on fund performance. Mutual fund investors who hold their investments typically earn higher returns over time than those who time the market.
Added: I’m not really trying to bag on 401ks, I’m trying to focus on the fact that tying to time the market has been very destructive for investors. For a related parable, read their story of Quincy and Caroline.