Transcript: Segment 1
Answering an Email on Investor Returns
Paul Winkler: So I have a friend of mine says I hate sending emails. You know, this is just because you don’t know the tone that’s coming through the email and that’s the case all the time. We just get inflection from written words that we don’t necessarily get if you’re talking to somebody, “when you say in your ads that investors typically get lousy returns.” John says, “over the past decades, are you willing to put numbers to that claim?” Was his question ”What should various investors have made based on different allocations?” Of course, some investments have the same allocation could be different based on the money, went out and went in, but it would be nice to have some ideas what that should be with Vanguard on.
He says, he’s apparently got an account with Vanguard currently 9.2% return over the past eight years, which seems pretty good. But perhaps people with a hundred percent equities have fared much better understand how you can’t compare what you gain, because I may have way more risk and, and just lucky are more heavily weighted in one area versus another one thing is that has hurt. My return is small cap index that hasn’t done that well, large cap over the last eight years. Just wondering if you could put some more concrete, specific numbers to claim of lousy returns and yeah, absolutely.
Good question, John. I appreciate the question. Number one, one of the things that if, if you look over the past eight years, it has been a very, very concentrated market. You can look at an investment portfolio and you can tell pretty much how it was allocated based on what the performance has been over a period of time. And in fact, there was a study done in 1986, repeated in 1991, repeat it several times thereafter, rinse. It wouldn’t be Bauer. And what they were looking at is what describes, how, how can you figure out what performance has been our, what to allocation has been based on performance.
Where does fund performance come from?
And what they found was that your allocation, your assets classes held describes 91 to 94% of performance. So in other words, if I look at your investment portfolio, I don’t even have to know what, what stocks you own. I don’t know, half, I don’t really have to know what about tactical asset allocation. In other words, market timing type things that have taken place inside the portfolio. All I need to know is what asset classes you own. And in my book, I actually talk about this, how it’s like investing in the stock market. It’s interesting because you look at a fund that is investing in a sector or a section or an asset class in the market.
And if you compare it to the asset class it’s investing in. So for example, if I have a mutual fund that is investing in large growth US stocks, and I compare that fund performance, just to what large U S growth stocks did, you will see, it’s like watching a set of railroad tracks. It moves right in tandem. Both of them movement within just fractions of teeny teeny movements will have each other. If I looked at a portfolio that was invested in small US stocks, you would notice that the fund didn’t matter, which small US companies were owned.
The movement of that fund would be in tandem with what small us stocks did in general. If I look at international, same thing and international value international small, it doesn’t really matter what asset category you’ll see that they move in lock step with each other because the same economic data tends to affect them all. Similarly, now, if I look at returns, I can say, you know, if you, for example, had a 10% positive return in the year 2000. Well remember that was when the tech bubble burst and stocks came crumbling down.
But if you had a 10% return, I could tell you unequivocally that you had your money in large value stocks, because they actually went up when the tech bubble burst. If you told me that you went up 35% in 2001, the next year, large growth companies went down 12, but small value went up 35%. I could tell you that’s where you were. If you told me that you actually had a positive return in the year 2002, that was after nine 11, I could tell you that you had your money in small international stocks.
So it’s what drives the performance is the asset category that’s actually held. If somebody had a very high return in the past five to eight years, I can tell you that most of your money is in more growth oriented, larger companies. And an index fund that is investing in small caps will be more growth oriented. Yeah. That would have hurt your performance, but it holds bigger companies because of the capitalization weighting. And then you’ve got the S and P 500 is probably driving a lot of your performance because large U S stocks.
And as you probably heard me say on here, you’ve got a huge proportion of the portfolio that is in the S and P 500 right now, just driven by six stocks. Matter of fact, if you look at an entire total stock market portfolio, and I’ll talk about this more later, but a total stock market portfolio and investing in the entire us stock market, like companies like Vanguard and fidelity have, you will notice that only two companies, two stocks make up to 10% of that portfolio, Apple and Microsoft. It’s, it’s insane. I’ve never seen it that skewed, but that is literally what’s making up so much of the performance of the market is as of late. And if those companies and those big tech companies, let’s say we have the same thing we had in the early two thousands, we’re going to be in trouble. You’re going to be in, I’m not gonna be in trouble. Cause I don’t have myself concentrated that way, but you’d be in trouble with a portfolio like that.
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Can you put numbers to that?
So back to the one question, which was, you know, what should a portfolio have done? Can you put the put numbers to that? Absolutely. I can put numbers to that. What I’m referring to when I referred to investor returns is there was a study by Dalbar research out of Boston. And they did research on investor behavior and they looked at what they were investing in, how they chose funds, what they put their money in when they moved it between various asset categories. And what they found is that if you look at 30 to 34, they got 34 year data.
Their 30 year data is typically what they stop. I guess they like round numbers, but they’ve got like 34 years of data. And the return is somewhere between four and 5% per year. That’s what the average equity mutual fund investor they estimate has gotten investing in the stock market, the average asset allocation investor. In other words, an investor that’s investing in both stocks and bonds and, and, you know, managing the portfolio. That’s an asset allocation fund. They’re allocating between various asset categories. That’s why they call it that.
So it’s the idea being that you’re reducing risk by diversifying more between various asset categories instead of just investing in a single asset class. If you look at that, the average investor, there is just over 2%, really, really bad. Now over the same period of time, a diversified portfolio is like, and when I say diversified, I would own something, you know, large companies have some small, large value, small value, international, international, small.
And I typically get into, this is in my book where I have, I talk about various asset categories. Now this isn’t even a portfolio. This is just indexing still, which I don’t advocate for small companies, but I don’t advocate indexing because you’re over-weighting big companies in a small portfolio, but I use it when I’m illustrating in my book just to, just to make it easy. You know, you give up return when you do that. In other words, what I’m saying. So I’m just gonna use that and save the return with somewhere between 9% and 10% per year, depending on how much in stocks, if you had about 25% in bonds, it was about nine.
If you had it all stocks, it was about 10%, which is actually a little bit lower than historically normal, just because we had so much grief in the past 20 years, you know, and look at the tech bubble bursting and then 2008 and then COVID and all of that garbage, but it was about 9% to 10% per year. And just to put that numbers that’s instead of $10,000 growing to, I think it’s $10,000 growing to $52,000 is what the average investor would have gotten at a 5% return.
So $10,000 grows to $52,000 versus it would have grown to about 255,000. So that’s when you hear me say that that’s a big difference about fivefold difference between the two of them. So, hence that’s why, you know, I look at investor behavior as the biggest issue, a lot of people are sitting there focused on, you know, can I shave 20 basis points off my fees? Or can I shave this much off of a management fee of a mutual fund? And a lot of times what they’re doing is they’re actually indexing to do it, which reduces returns elsewhere because you’re overweighting big companies and you’re not really getting the management of the portfolio where it is focusing more on value and small, which is where you get the boost in returns.
Historically, that’s where the bigger returns, 83% of 20 year periods, small does better than large and 96% of 20 year periods value does better than growth, but what happens then you’re overemphasizing big and growth. You’re going the opposite direction. In other words, with indexing, but indexing works real well with largest. So that, that would be, that would be my answer to that. The thing is is that if you look at the Dalbar study, it goes back 34 years. The first time I saw this study, it actually looked at just a short period of time, 15 years.
And it was a huge difference. They’ve narrowed the gap in recent years. Investors have, for what reason, you know, probably more because larger stocks have done better more recently and investors tend to be more enamored with that. So they probably narrowed the gap for that reason where the return differences in as big between equity funds and diversified or market returns, but they’re still, still beneath significantly. But the thing back then that was interesting is when they did the research back, then they actually looked at investors that were, do it yourself, investors versus brokers.
And they found the brokers were getting just as bad a returns, just slightly better than the investors. And the reason had to do with again, the same type of behavior, how they buy things when they buy things, when they put money in how they, how they put money in.
Where do the numbers come from?
These returns aren’t only Dalbar finding the same results. You have to buy the Dalbar research. They actually sell that research to the public , and you can go and buy that. Morningstar has something, too. They have a program and it’s pretty expensive, but the data is on there as well. And I know I pay like $13,000 a year for the data.
I think there’s a less expensive version and it may have this data on it. But basically what it does is it talks about what investor returns have been in funds versus the fund return, which is really fascinating because again, it gets down to the cash flows when they put money in how they put money in and, and when they choose and what, what investment vehicles they choose and when they move money between investment vehicles, because, you know, instincts and emotions, they drive investor behavior pretty significantly.
And you know, so yeah, there, there is data behind all of this. When I talk about investor returns versus market returns, there’s a lot to it, but the biggest thing really is behavior. There are other issues and the typical funds that they tip that they buy using retail funds, as opposed to institutional and using indexes index is infinitely better than active management. You’ll hear me say that often, instead of having somebody go and pick stocks and time the market for you, it’s a waste of time.
Indexing is a better way to do it, but you know, typically what I like to do is only index a couple areas of the market, large U S and large international. And after that, I like to go for something that is not quite as lazily managed.
All right. That’s it for the Investor Coaching Show today. If you enjoyed it, I am Paul Winkler.
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