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  • Writer's pictureEric Hahn

Study: Investors Are Dumb

How dumb are investors? Pretty dumb, new research indicates. According to the Quantitative Analysis of Investor Behavior report from Dalbar, a financial research firm, equity fund investors earned an average annual return of 3.69 percent for the 30 years through 2013. The S&P 500 returned 11.11 percent during the same period "There is simply no substitute for good judgment. But it remains in remarkably short supply," writes Robert Seawright, chief investment and information officer for investment advisor Madison Avenue Securities, for Research magazine. "Attempts to correct irrational investor behavior through education have proved to be futile," the report states. "The belief that investors will make prudent decisions after education and disclosure has been totally discredited." The research indicates that financial advisors have a tremendous opportunity, Seawright says. Unfortunately, professional money managers don't have a great record either. Financial advisors are often overconfident, trade to frequently and exhibit herd behavior. "A variety of behavioral and cognitive biases constantly conspire to limit the abilities of laypeople and professionals alike to make good investment decisions," Seawright adds. "Accordingly, we’re right to be skeptical about our decision-making abilities in general because our beliefs, judgments and choices are so frequently wrong." Wall Street Journal columnist Jason Zweig says investors aren't quite as dumb as the study suggests. The study's "quirky formula" for calculating returns accounts for the unusually large gap between the S&P 500 and investors' returns. "To calculate investor return, all the other studies use a standard formula that adjusts the results to account for when the performance was earned and when money moved in or out of the fund," Zweig notes. "Dalbar's formula . . . has the effect of taking returns over the full period and dividing them by the total assets at the end — including money that wasn't in the funds from start to finish." However, there's definitely a gap. Research by accounting professor Ilia Dichev at Emory University finds that investors lagged the market by 1.3 percentage points annually from 1926 to 2002, according to Zweig. A variety of research has shown that both individual investors and pension funds and other supposedly sophisticated investors underperform the funds they purchase due to jumping in and out of investments. Investors hurt their returns by jumping in and out of the market, he says. They take out money when they need it for major expenses like college tuition or a down payment for a house. Worse of all, they jump into stock funds in vain attempts to chase returns and yank out money in fright during down markets. "Even if you’re a disciplined investor, it will hurt your results if you buy a hot-money fund," Stephen Janachowski, president of investment advisor Brouwer & Janachowski, tells Zweig.

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