What Can We Learn From Examining Equity Fund Investors Buy/Sell Decisions?

 
After the stock market's severe decline in 2008, there were a blizzard of articles proclaiming the death of buy-and-hold investing and advocating that investors dump stocks and buy gold as it breached $1000 early in 2009.

Those who bought into the "new" thinking and sold stocks and bought gold have missed out on one of the strongest global stock market rallies in history after selling at historically depressed prices. Gold meanwhile has treaded water since early this year (and remember that unlike stocks, gold pays no dividends).

Trying to time moves into and out of specific investments sounds good in theory. Who wouldn't want to sidestep stock market declines and then buy back in at lows before stocks go higher?

The refrain I heard over and over from investors who sold stocks late in 2008 and early 2009 was, "I'll Wait Until Things Look Better to Invest." Well, that didn't work out so well - now that it's getting late in 2009, it's finally becoming clear that the global economy is much healthier but global stock prices are already up more than 60 percent from the lows!

Recent history isn't the only time period when market timing has turned out badly for investors. Professors Geoffrey Friesen and Travis Sapp examined 14 years worth of money flows for over 7,000 mutual funds. They found that timing decisions by investors reduced their annual returns by about 1.6 percent per year below what those investors would have earned through buying and holding. This under performance persisted and was consistent through both up and down markets.

The professors found that investors made worse timing decisions when it came to withdrawals (selling) than they did with purchases (buying). Selling decisions led to an annual under performance of about 1.8 percent per year versus under performance of just 0.7 percent per year with buys. This makes sense to me because more often than not, folks who panic and sell during a stock market decline tend to sell nearer the end of the decline and then fail to get back in before the rebound, which is usually sharp.

Investors in load fund (who are generally dealing through a broker/salesperson) made worse timing decisions (lagging buy and hold by about 1.9 percent per year) than did investors in no-load funds (who lagged buy and hold by about 0.9 percent annually). The study's authors attribute this to the possible propensity of brokers to pitch investors larger, more well know funds after a period of high performance. This performance chasing inevitably ends badly because it sucks investors into overheated sectors near their peaks (e.g. technology stocks in the late 1990s). The worse timing of those dealing with brokers is also noteworthy to me because over the years and decades, I've heard again and again that broker-advised customers won't make dumb moves like panicking and selling after a major decline. The data show otherwise.

The timing decisions of those moving money into and out of actively managed funds was worse in aggregate by about one full percent annually than that of index investors. I suspect this is because index fund investors tend to better educated and therefore, less likely to foolishly believe that they can outfox the markets.  

In conclusion, the professors stated, "Overall, our results commend the relative appeal of a simple ‘buy and hold' strategy to the average investor...it appears that investors tend to under perform a buy-and-hold strategy in all manner of market conditions." This confirms what I observed during my years of work as a personal financial advisor.