Openfolio, a company dedicated to providing information and transparency to investors, recently released some data about how investors performed in 2016. Openfolio aggregates the performance data from over 70,000 subscribers who voluntarily and anonymously share their investment portfolio information with Openfolio. The idea is that sharing data among its users should help them realize better investment performance. We will discuss whether that actually occurs a little later.
Openfolio recently shared some data and insights about the performance of its investor subscribers with CNNMoney. One of the datapoints was that 77% of Openfolio’s investors made money (had positive investment performance) in 2016. Another interesting insight was that women outperformed men (in terms of investment performance) for the third year in a row. The most interesting piece of data revealed that the average investor reporting data to Openfolio made just over 5% on their portfolio in 2016.
What is interesting to note is that Openfolio’s data supports findings from other leading financial industry researchers. Dalbar is one such researcher that we have referenced periodically in this newsletter. Dalbar’s data through 2015 (2016 data is not finalized yet) shows that the average investor earned a 4.67% annualized rate of return in the fifteen year period beginning in 2001 and ending in 2015.
Not to toot our own horn, but by comparison our portfolios performed much better than the results seen from the average investor in the Dalbar study or the average subscriber to Openfolio. Our 100% Equity portfolio (appropriate for very aggressive investors in the early to middle stages of the wealth accumulation phase of their lives) returned 14.92% in 2016 (not adjusting for advisory fees). The 100% Equity portfolio is certainly not appropriate for all investors, especially those in the later stages of wealth accumulation or in retirement. For these investors, our 60% Equity/40% Fixed Income portfolio is the more appropriate choice. Our traditional 60/40 portfolio enjoyed a 9.56% gain in 2016. Because of the low interest rate environment we have been facing for the past few years, we have shortened our bond portfolios up to protect clients from the effects of rising interest rates. Our low duration 60/40 portfolio was up 9.18% in 2016.
You may be wondering why the ‘average investor’ receives significantly lower investor returns than what is available from our portfolio models. While there are probably many different factors involved, a great deal of the underperformance can probably be explained by behavioral flaws that many investors exhibit.
Behavioral finance is a growing field that could encompass dozens of newsletter articles. Let us focus on three likely culprits for the average investor’s underperformance: market timing, short-term focus, and performance chasing. Market timing is buying or selling financial assets by attempting to predict future market movements. Perhaps there is no better example of the futility of attempting to time the market than 2016. January of 2016 saw the S&P 500 index decline 5%, yet the index returned 11.96% for the entire year. Investors following a popular Wall Street myth, the January Barometer, would have believed that January would have predicted the market performance for the year and sold out in February, thereby missing out on big gains. Likewise, investors reacting to the Brexit threat in June or the Presidential election in November would have also missed out on huge gains.
Performance chasing is another behavioral finance problem that habitually locks investors into poor investment returns. The Dalbar study indicates that the ‘average investor’ holds an equity (stock) fund for slightly more than four years, and holds a fixed income (bond) for slightly less than three years. One of the reasons that investors would change funds so frequently is performance chasing: trying to find the hot fund manager. Investors sell out of one fund that has underperformed recently; and purchase another fund that has outperformed of late, only to be subsequently disappointed later on when that fund underperforms. This behavior plays right into the hands of Wall Street’s commission sales culture.
Ultimately, most investor’s behavior problems can be traced to short-term focus. Having a short-term focus leads to market timing and performance chasing behaviors. It is no wonder many investors have a short-term focus: investors are trained to be short-term focused by the media and even websites that endeavor to help investors like the before-mentioned Openfolio. A brief exploration of Openfolio’s website finds a section labeled ‘Insights.’ The Insights section shows summaries for each month with headlines reading “Over 75% of investors made money in August” and “80% of investors lost money in October.” Who cares? Well, I know one group who does care: Wall Street’s brokerage firms whose compensation is largely driven by investors trading. But the average investor should not care about monthly performance numbers: they really do not mean a thing when it comes right down to it. Having a short-term focus as an investor will lead to bad decisions because the market reacts to news every single day, sometimes negatively and slightly more often positively. The performance numbers shared by Openfolio about its investors’ performance seem to confirm this.
While it is sometimes interesting and amusing to read how the ‘average investor’ performed in any given time period, or how much the ‘average’ engineer is compensated annually, averages don’t really tell us very much. There are so many variables involved in any study of averages, that the data is probably not very germane to your specific situation. Perhaps when we see these snippets and articles we should ask ourselves, “Have I ever been happy with average?” How many of us aspired to be ‘C’ students in school? And really, who wants to have the ‘average’ retirement? You have (or will have) worked much too hard to endure an average retirement; you deserve the retirement of your dreams. Keeping a long-term focus and ignoring the short-term noise is the first step in realizing that dream.