A recent study by Dalbar, “A Quantitative Analysis of Investor Behavior (QAIB) released in 2014 is the 20th annual addition to a report that examines the returns investors earn compared to the performance mutual fund report. In the short term, fund holders earn less, in many cases much less than mutual fund performance reports suggest.
Because fund participants bought when the funds were performing well, but sold when their holdings went down in value. Even when Peter Lynch ran the large Magellan Fund, the average shareholder return was poor compared to the fund’s performance. This is entirely attributable to the behavior of investors.
If you are a plan sponsor or participant, what action can you take to correct this problem?
I think it’s investor education. The typical education offered to plan participants is to discuss asset allocation and age-based recommendations. This type of teaching does nothing to solve the main problems related to investor behavior. This has been proven because the problem has not been fixed after 20 years of reporting results.
The Pension Protection Act, which strengthens employers’ existing pension obligations and discourages them from taking on new obligations, also makes a point to American workers: The overall message of the bill is that you are alone. A key provision of the law is that it allows employers, through their 401k providers or third parties, to offer investment advice to plan participants without substantial fear of being sued by employees unhappy with their investment results.
Advisors can make a difference
Recent studies have shown that employees who use an investment advisor have earned approximately 3% more per year than the average employee who makes these decisions themselves. Three percent over a long period of time is an extraordinary difference. Over 24 years, this difference doubles the principal amount. Forbes magazine has published a few articles discussing the benefits of working with an advisor. Most of the difference has been made by helping the employee stay in declining markets and rebalancing funds held quarterly. Additionally, employees who work with an advisor tend to increase the risk they take.
There are different types of advisers. Many are salespeople who spend little time on actual fund management but focus on annuity sales and asset allocation. For your retirement, the engine that drives your financial plan is real money management. To me, this means that you need someone to pay daily attention to the investments underlying your plan, especially if it increases the risk you take.
My experience has been that in order for you to get the best results and feel comfortable with your personal investments, you must understand the strategies that are employed to achieve your personal goals. Many people hire an advisor and expect low risk and high rewards without any personal effort. This type of relationship is likely to fail.
Understanding market cycles is important
Cycles are literally everywhere. They are found in nature, in business, and in ourselves. The regular ebb and flow of the tides, the phases of the moon, and the succession of the seasons are examples of cyclical activity. The concept “cycle” refers to a measured or rhythmic pattern of activity, a process that moves from beginning to end and then begins again, up, down, up, down. Inside, outside, inside, outside. Breathing. Heartbeats.
What does this have to do with investing? Much. Because stock prices also move in cycles. In the broadest sense, the rise and fall of stock prices can reflect the life phases or life cycle of an entire economy. More specifically, the price of a single share may reflect the life cycle of the corporation it represents.
There are a number of highly sophisticated mathematical techniques that can be used to study cycles. By applying these techniques to stock prices, we can find evidence that many cycles operate simultaneously. They vary in duration from a few days to fifty years. All of these cycles interact with each other and combine with historical events to produce the seemingly random and choppy price movement that we see illustrated every day in the Wall Street Journal.
Let’s look at the cycle of a heart beat.
Observe the period of silence followed by a rapid upward movement and then another rapid downward movement until the beginning of the next period of silence.
Many stocks have similar patterns
Observe the waiting period followed by a quick upward movement and then a downward rapid movement until the beginning of the next period of silence.
Generally speaking, the longer the foundation, the higher the price increase it can support.
Understanding the four-year cycle is critical!
How can this help you better manage your money?
If you look at a chart of the Dow Jones industrial average, for almost a century there has been a great buying opportunity roughly every four years. The other important indices would also correlate with these lows. Therefore, you should take more risk at these low points and less risk at the high points. It is a simple task. Look at the last important minimum and calculate four years. If the low occurs more quickly, you can buy at an earlier date. Upward trends last for about three years. Major downtrends can last for about a year and a half. If prices have been rising without a major correction for about three years and the next low point is scheduled for late 2015 or early 2016, you shouldn’t take a high risk, but instead should save cash for the next big opportunity. Markets tend to rise at a faster rate just before the uptrend matures. If you are taking market risk, you need to follow up on a daily basis with a risk control plan.
Investors who make decisions based on past performance and seek the best performing funds over 3 months, 1 year, and three years of history, by definition, buy at the top of the market cycle.
Even if you are an experienced investor determined to go your way, our children and grandchildren must learn these important principles so they can develop the faith and strength it takes to create wealth through saving and investing.
Investors who took this approach would not have lost a lot of money in 1987, 2000, 2006, or 2009.