Recently Dalbar reported that the average equity mutual fund investor experienced returns of 5.5% in 2014 compared to the S&P 500 Index return of 13.69% more than 8% less.
Dalbar also reported that the average fixed income mutual fund investor received a return of 1.16% in 2014 while the Barclay's U.S. Aggregate Bond Index returned 5.97%. In terms of magnitude, this is even worse as fixed income mutual fund investors received more than 5 times less in returns than the index.
Is this an example of active management underperforming passive, or is there something else at work? The folks at Dalbar conclude that the performance differences, because they are so large, are attributable to bad investor decision-making.
Unfortunately, Dalbar's studies show that 2014's mutual fund investor performance is not a one-time event. The average mutual fund investor typically underperforms the indexes each year by a wide margin. What can 401(k) plan participants (who comprise the majority of mutual fund investors) do to keep from sabotaging their annual returns? Plan participants should:
- Never, ever try to time the markets. Market timing involves making buy or sell decisions based upon a prediction of future market movements. For example, assume that war appears imminent in the Middle East and a plan participant hears on the news that the price of oil may rise. Recalling that his 401(k) plan offers a mutual fund that invests in commodities, a participant decides to transfer all of his account balance into that fund. Two days later the rumors of war appear to be unfounded, and the price of oil and the commodities fund, crash.
- Never trade a 401(k) plan account. Some plan participants view their 401(k) plan account as a trading account that they can build in size by executing various trading strategies. Trading a 401(k) plan account is not a sound wealth building strategy. Unless a participant has significant trading expertise, can hire an expert or can afford to lose all of his/her retirement savings, there are much better approaches to building a retirement plan nest egg.
- Ignore the newsletters and their co-workers. There are a number of very large 401(k) plans that have current or former employees who issue buy/sell recommendations on the investment options in these large plans. Participants should ignore them. Unless a participant can execute all of their recommendations exactly when issued, they will never be able to replicate their performance.
- Never buy or sell a mutual fund for emotional reasons. Participants that are rattled by the markets and think they will lose everything each time the markets fall should get help from a qualified investment advisor. They shouldn't make trades in their 401(k) plan accounts without professional guidance. What they will pay in advisor fees is far less than what they will lose by making bad trades.
Plan sponsors should consider including these tips on participant investment decision-making in their next employee education session.
Robert C. Lawton, AIF, CRPS is president of Lawton Retirement Plan Consultants, LLC, an RIA firm helping retirement plan sponsors with their investment, fiduciary, employee education and compliance responsibilities. He may be contacted at email@example.com or 414.828.4015.
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