A Better Investment Experience: Three Tips

A Better Investment Experience: Three Tips

A Better Investment Experience: Three Tips

The road to financial success is paved with lots of twists and turns. Making matters worse, most investors don't seem able to get out of their own way. 

In the past 30 years (1989-2018), the typical stock fund investor in the U.S. gained a compounded annual return of 4.09%, according to Dalbar Inc. That might sound pretty good, until inflation is taken into account, which the independent research firm found averaged 2.49% a year during such a period. At the same time, the S&P 500 index generated annual returns averaging 9.97% a year.1

Bond investors have also generally come up with underwhelming results when compared to an investment-grade benchmark over the past three decades. In the 2019 version of their long-running research series ("Quantitative Analysis of Investor Behavior"), Dalbar's analysts estimated that an average fixed-income investor's compounded annual return during this period lagged the Bloomberg Barclays Aggregate Bond Index (0.26% vs. 6.10%). 2

Dalbar President Louis Harvey credits much of this perpetual underperformance by fund investors to a natural tendency to overreact to short-term changes in market conditions. After years of studying such investment behavior, he tells us that "investors' risk tolerance is very susceptible to fluctuations in fund values." At the same time, he adds, a typical fund investor "shows an innate proclivity to sell at just the wrong time whenever there's market upheaval."3

Based on our own research as well as work done by Dimensional Fund Advisors in studying the dynamics of behavioral finance and market volatility over extended periods, below are 10 evidence-based tips. These are offered as a few common themes used by our wealth advisors to help create a better investment experience for fund owners of all stripes, whether they're novices or veterans. 

Tip #1: Take Advantage of Market Pricing, Don't Fight It. 

Instead of trying to outguess others who might be making billions of dollars worth of equity moves on any given day, focus on what free-markets do best. Namely, such a system creates a real-time means for buyers and sellers to exchange securities at prices which each side of the transaction can accept as valid and fair. 

Understanding market pricing is an important enhancement to the investment experience in terms of helping you to step back and focus on the bigger picture. Keeping in mind how markets are structured to work in the aggregate will free your investment decisions to be guided by a more stable knowledge of how price elasticity can be your friend over time, not your enemy. 

This is a theme we've been writing about for years. It's such a core element of our investment process that IFA's founder, Mark Hebner, has created a model to explain just how fair pricing is achieved on a regular basis. It's depicted using an interactive chart that illustrates just how such a process works. (See "The Random Walk of Market Returns" chart below. Included are links to videos and in-depth articles on the topic.) 

Tip #2: Don't become a 'Time Picker'

At IFA, we refer to investors who think they can move in and out of markets with any sense of consistency as "time pickers." Still, avoiding big market downturns can be alluring. The problem is that trying to actively pick your spots runs into quite a conundrum. As Hebner puts it: "The predicament is that the market's worst days tend to be equally concentrated and just as difficult to identify in advance as the best days."

The chart below shows that missing the 40 worst days in the S&P 500 Index during a 20-year period (1999-2018) would've increased investment returns by 372.87% as compared to a buy-and-hold investor's gains.

By contrast, investors who weren't on the right side of trades in both instances -- jumping in and out -- faced even more damage. As illustrated below, the flip side of the coin is that missing out on 40 of blue chip stocks' best days would've resulted in a triple-digit percentage loss during this timeframe.

Tip #3: Let Markets Work in Your Favor

Patience is a virtue. In fund investing, this has proved especially true. Historically, equity markets have provided broad opportunities for growth of wealth over time. Consider the interactive chart below. 

On the top, you can compare annual returns for different IFA Index Portfolios with varying levels of stocks and bonds. (Index Portfolio 80, for example, has 80% allocated to stock funds. Meanwhile, Index Portfolio 20 has 20% in stocks.) Also, clicking on other icons brings up overlays of graphs for different indexes and asset classes. 

In particular, look at the bottom half comparing growth of $1 over 50 years (through 2018). You can choose IFA Index Portfolio 100, which is a globally diversified all-stock portfolio. Then, hover over the "SV" icon to see gains by the IFA Small Cap Value Index. Or, pick "EV" for the IFA Emerging Markets Value Index. A number of other combinations are available to evaluate using this tool. 

At the lower end of the spectrum is the "IF" icon. This represents the IFA One-Year Fixed Income Index, a conservative benchmark covering short-term and high-quality (investment-grade) bonds. 

Notice that either way $1 dollar was invested, putting money into the types of assets courting historically higher levels of risk have done better. This makes sense, given that applying an efficient frontier analysis -- where raw returns are judged relative to how much market risk is being injected into a portfolio -- has been identified by leading academics as key to long-term investment success. 

As a result, staying away from urges to react to short-term market conditions goes hand-in-hand with selecting a proper asset-allocation plan for a diversified portfolio. 

Based on a wealth of independent academic research as well as our own scientific evaluation of market behavior, we've developed a series of questions to help investors strike the right balance between different asset classes. The IFA Risk Capacity Survey can be taken online at your leisure.

It's often used by not only new clients, but also those who've been working with one of our advisors for many years. After all, life changes and each unique financial situation evolves over time. Taking another run at this survey can only enhance any ongoing assessment of your progress in developing a rewarding investment experience. 


Footnotes: 

1. Dalbar Inc., "Quantitative Analysis of Investor Behavior," 2019.

2. Dalbar Inc., "Quantitative Analysis of Investor Behavior," 2019.

3. Phone interview by IFA with Louis Harvey, president at Dalbar, 08/09/2019. 


This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product or service. There is no guarantee investment strategies will be successful.  Investing involves risks, including possible loss of principal. IFA Index Portfolios are recommended based on time horizon and risk tolerance. Take the IFA Risk Capacity Survey (www.ifa.com/survey) to determine which portfolio captures the right mix of stock and bond funds best suited to you.  For more information about Index Funds Advisors, Inc, please review our brochure at https://www.adviserinfo.sec.gov/