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Buying High and Selling Low

Scott Matheson, CFA, CPA
Senior Director | CAPTRUST Defined Contribution Practice Leader

Mark Paccione, CFA, CFP® 
Director | CAPTRUST Consulting Research Group

In 2012, the average equity mutual fund investor earned 15.56% — just short of the S&P 500’s 15.98% return.1 The average fixed income mutual fund investor earned 4.68%, while the benchmark Barclays Aggregate Bond Index returned 4.21%.2 Unfortunately, average investor outperformance over common market benchmarks is a rare occurrence. For example, in 2011 the S&P 500 Index returned 2.12%, while the average equity mutual fund investor lost 5.73%.3 Admittedly, global equity markets experienced a particularly volatile year as Standard & Poor’s downgraded the U.S. federal government credit rating in August 2011, and the European sovereign debt crisis sent many equity investors to the sidelines. The Barclays Aggregate Bond Index, which tends to react well in volatile equity markets, had a much better year, up 7.84%. The average fixed income mutual fund investor received a meager 1.34% return,4 which is better than the average equity investor did, but significantly worse than the Barclays Aggregate benchmark.  

More importantly, 2011 is not an isolated incident. Findings by financial research firm DALBAR indicate that the average mutual fund investor consistently underperforms the market. In its annual Quantitative Analysis of Investor Behavior study, DALBAR notes, “One of the most startling and ongoing facts is that at no point in time have average investors remained invested for sufficiently long periods to derive the benefits of the investment markets.”5 Figure One captures the average investor’s plight — which is especially obvious over longer periods.


Timing is a key contributing factor to the average investor’s underperformance. The same DALBAR study also shows mutual fund flows tend to lag market movements, causing investors to unintentionally buy high and sell low. Equity fund inflows tend to increase after run-ups in the S&P 500. Meanwhile, outflows tend to pick up after market sell-offs. For example, fund outflows in the first six months of 2012 were greatest at the S&P 500’s bottom, and fund inflows were greatest in December when the S&P was trading near year-highs. Figure Two, which plots investor fund flows versus market performance for calendar year 2012, illustrates this point.

These trends seem illogical, yet they are explainable. Several behavioral biases play a role in contributing to the ill-timed investment decisions, including what psychologists call herding, confirmation bias, and loss aversion. 

• Herding is the tendency of individuals to follow the group’s actions. If everyone is buying and equity markets are going up, the individual investor is compelled to go along with the crowd. People tend to conform to the group because individuals believe it is unlikely the group is wrong. The dot-com bubble in the late 90s and the more recent housing bubble are perfect examples.

Confirmation bias is the tendency to accept data that confirms existing beliefs—while rejecting data that contradicts them. With every market rally or decline, market participants (assisted by financial news outlets) assign a reason behind the latest capital market move, whether that reason is a recent economic data release, comments from an influential source, a corporate earnings release, or even the time of year. When equity indices are rising, individuals have a tendency to overemphasize the positive data points, while ignoring the negatives; when equity markets decline, individuals do just the opposite.

• Finally, loss aversion is particularly detrimental to investors in market downturns. Research has shown that individuals prefer avoiding losses much more than experiencing gains.7 When equity markets correct, many individual investors reduce equity holdings in order to avoid further losses. In the long run, however, investors would be better served increasing equity holdings in a down market.

While the average mutual fund investor’s underperformance is understandable, there is a cure. Asset allocation — while not trendy and certainly not a new concept — can help overcome these behaviors. The principle of combining multiple assets that are not perfectly correlated to one another as a way to reduce overall portfolio risk still holds true. In an accelerating economy, where corporations are doing well and investors are feeling better about the future, equities would likely appreciate. In a decelerating economy where corporate earnings are suffering, equities may perform poorly. Meanwhile, traditionally safe investments like fixed income securities would likely do well and offset some of equities’ declines. If nothing happens and the financial markets move sideways, the investor collects interest and dividends. 

Asset allocation allows an investor to build a portfolio that is not overly dependent on a single factor such as rising equity markets by combining asset classes that respond to different factors. More importantly, an investor with a well-diversified portfolio can maintain a steady course, knowing that, even in volatile markets, some portion of his portfolio is doing well.

A disciplined approach to making investment decisions is required if one is to avoid these detrimental behavioral tendencies. For defined benefit plans, this means engaging professional advisors to work alongside a plan investment committee following a well-constructed investment policy statement. The challenge is different for defined contribution plan sponsors where individual participants directing their own investments are susceptible to these tendencies. 

To mitigate the risk of participants making ill-timed investment decisions, a plan sponsor must understand its audience. Disengaged participants (or delegators) who fail to take action are fundamentally different than hyper-engaged participants who may actively rebalance their investment holdings. To help the delegators, plan sponsors can take advantage of the very inertia and lack of engagement of this population by automatically enrolling them into a QDIA. For those participants who are modestly engaged, asset allocation models, education, and advice, along with a limited number of diverse investment choices, can help. Finally, and ironically enough, hyper-engaged participants may be the most susceptible to behavioral biases. For this subset, targeted and timely communication during times of financial turmoil, advice phone lines, and managed accounts are just a few tools to help avoid missteps.

The basic takeaway from the DALBAR study is clear. Without assistance, the average individual investor is fighting an uphill battle; however, with the help of asset allocation, a well-thought-out plan design, and the right kind of participant engagement, one can dampen or even eliminate many of the biases that contribute to long-term underperformance.


1 DALBAR, Inc. Research & Communications Division. 2013, Quantitative Analysis of Investor Behavior: Advisor Edition. Boston, MA. March 2013 page 17
2 Ibid
3 DALBAR, Inc. Research & Communications Division. 2012 Quantitative Analysis of Investor Behavior: Advisor Edition. Boston, MA. April 2012, page 9
4 Ibid
5 Ibid, page 5
6 DALBAR, Inc. Research & Communications Division. 2013 Quantitative Analysis of Investor Behavior: Advisor Edition. Boston, MA. March 2013, page 19
7 Kahneman, D. and Tversky, A. (1984). “Choices, Values, and Frames.” American Psychologist 39 (4), pages 341–350



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