The Fallacy behind Investor versus Fund Returns (and why DALBAR is dead wrong)

It has become accepted, conventional wisdom that investors underperform their investments by timing those investments badly. This conclusion has been arrived at by combining (1) a desired result (for financial professionals whose compensation is contingent on accumulating assets); with (2) perceived “common sense” (perhaps inculcated by the desirability of that result); and (3) incautious, cavalier application of an inadequately-analyzed, poorly-understood mathematical measure.

As I will explain, there is no way to determine if investors underperform the mutual funds they own, either because of bad timing or for any other reason.

Why is it a desirable result for investment professionals?

A company named DALBAR has found success by publishing a report each year titled “Quantitative Analysis of Investment Behavior” (QAIB). For $775, it allows an advisor to buy the right to use all of the QAIB’s charts and data in its marketing materials.

Of course, this report invariably shows that the investor makes serious errors and needs help. If it didn’t, DALBAR would sell no copies of its report to financial advisors and would quickly go out of business. This fact itself – together with the fact that it is difficult to find out the exact details of DALBAR’s methodology[1] – should be enough to provoke skepticism about the QAIB’s perennial result, which is that mutual fund investors underperform their investments by a large margin.

DALBAR’s recurring result has been turned into conventional wisdom, something to be drilled into investors’ minds repeatedly, in various ways, to keep them aware of their behavioral investing foibles. For example, Figure 1 below shows a widely circulated cartoon by Carl Richards, illustrating how investors repeatedly buy at market tops and sell at market bottoms.

Figure 1. Carl Richards’ investor-fail diagram

Wouldn’t it be wonderful to have a client who invested as reliably as that? All you’d have to do is buy when the investor sold and sell when the investor bought, and you’d earn a tremendous return.

But investors don’t buy precisely at market tops and sell precisely at market bottoms. Perhaps they do sell on market panic and buy on exuberance, but that’s a long way from selling at bottoms and buying at tops. Figure 2 shows my hypothetical example of a more likely scenario of panic-selling and greed-buying, one in which the buys and sells are not so perfectly market-timed but are more realistically random.

Figure 2. More realistic “irrational” buying and selling

S&P 500 data from

In Figure 2, notice that the “irrational” investor sells in panic after a drop, and buys on anticipatory exuberance after a rise. In fact, in each case in this depiction, the investor sells, disadvantageously, at a local minimum and buys at a local maximum.

And yet this particular investor has in each case sold at a higher price than she bought. So in this particular arbitrarily-constructed case, our investor beat the market. Of course, the long-term investor would, in all probability, do better by not trying to time the stock market – which means being out of the market for periods of time – but by staying in the market persistently at the level of allocation chosen.

Nevertheless, the scenario depicted by Figure 1 will be much more attractive than the one in Figure 2 to financial advisors, who can use it to show their clients the mistakes they are likely to make if they are not held to a discipline by their wiser and more-experienced advisors. Hence, the value of the DALBAR report to financial and investment advisors.