There is much talk in the financial media about the market volatility that commenced in 2008. The markets experienced a very sharp downturn in 2008, and a remarkably quick recovery in the ensuing years. You would think that investors who relied on their brokers or advisers for advice during this period would have fared well. Market volatility should provide the perfect environment for investment pros who say they can time the markets.
Unfortunately, the opposite occurred. Investors were caught by surprise at the steep market decline in 2008, and some of them panicked, sold, and missed the market recovery.
According to an analysis by Byran Harris, senior editor at Dimensional Fund Advisors, the market began its steep decline in late 2008. It bottomed out in early March 2009 and then began a rapid recovery through June, 2011. During this period, investors dumped over $266 billion of their U.S. stock mutual funds. The biggest outflows occurred in early 2009, just as the markets began to recover. Net outflows remained negative even after the market recovery.
This pattern of bad investor behavior was not unique to this time period. Russel Kinnel, the director of mutual fund research at Morningstar, analyzed investor returns for the past decade in an article aptly titled: Bad Timing Eats Away At Investor Returns. Here's what he found: For the decade from 2000 to 2009, the average investor in U.S. stocks earned a pathetic 0.22 percent annualized, compared with 1.59 percent for the average fund. Investors in all funds also significantly underperformed the average fund, earning an annualized return of 1.68 percent, compared with 3.18 percent for the average fund. Investors in municipal bond funds did worst of all. They earned only a 2.96 percent return, compared with total returns of 4.57 percent annualized.
Kinnel has a number of suggestions for investors who want to avoid these dismal results. He counsels investors to "steer clear of higher-risk funds" that led them to make poor timing decisions. Curiously, he suggests taking a look at the valuations of your fund after rallies and sell-offs because "fund portfolios tend to be real bargains after a long sell-off and rather unattractive investments after a long rally." This seems like the kind of market timing that got investors into this mess.
Kinnel ignores the elephant in the room: The advice you received from your broker or adviser during this period. Many money managers advertise their ability to time the markets by telling you when to get in and when to get out. This data, and reams of academic studies, demonstrate they don't have this expertise. Relying on brokers has cost many Americans their opportunity to retire with dignity, if at all.
The real lesson is never mentioned by Kinnel. Fire any broker or adviser who tells you he can beat the markets by engaging in stock picking, market timing, or picking actively managed mutual funds or hot fund managers that will outperform the markets. Instead, focus on your asset allocation, the division of your portfolio between stocks and bonds. Purchase a globally diversified portfolio of low management fee stock and bond index funds, exchange-traded funds, or passively managed funds. Rebalance your portfolio once or twice a year to insure your risk level is appropriate for you.
Ignore short term market volatility. The greater your exposure to stocks, the more volatile your portfolio will be. If you are in the right asset allocation, you can ride out these bumps in the road and reap the expected returns that have historically been earned by long term investors.
The current system is fundamentally flawed. You don't have to participate in what amounts to nothing more than a charade of faux experts exploiting your nest egg.
Dan Solin is the author of the New York Times best sellers, The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, was released in September, 2011.
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