Are Individual Investors Destined to Fail? | Epou

Posted by Eta Phi Sports on Jul 28, 2012 in investing | 0 comments

It?s axiomatic among financial-service professionals that most do-it-yourself investors are their own worst enemies, always in the grip of some cognitive bias or other leading inexorably toward the worst possible investment decision.

Or are the professionals too pessimistic? True, there is a long history of self-directed investors generally underperforming and sometimes going up in smoke. But there is also recent evidence that, while most of us still do worse than the funds we invest in, we?re collectively closing the gap and managing to tame certain value-destroying reptilian impulses.

A Vanguard study released this month, for example, challenges the notion that the rise of the exchange-traded fund?which investors can trade at will, like a stock?would create a culture of day traders who?d throw long-termism to the winds and gamble away their savings. Enthralled by the "ETF temptation effect," the theory went, a self-selected group of active investors would gravitate to ETFs, where they?d chase past performance, run up transaction costs and generally behave like reverse indicators on autopilot.

[See How not to Pick a Mutual Fund.]

"ETFs introduce a different type of investor that doesn?t exist on the mutual-fund side, and that?s the day trader," says Lou Harvey, president of Dalbar, inc., a Boston analytical firm whose annual "Quantitative Analysis of Investor Behavior" (QAIB) documents the wayward performance of individual investors.

For all that, the Vanguard report ("ETFs: For the better or bettor?") argues that such funds are not weapons of self-destruction, after all. "In general, both ETF and traditional mutual fund shareholders proved to be long-term, buy-and-hold investors," it concludes. The study is based on 3.2 million transactions in more than half a million accounts held in various Vanguard mutual funds and ETFs over four years through 2011.

Some key findings: 62 percent of ETF accounts fell into the buy-and-hold category, which Vanguard defines as an investment held for more than a year and experiencing no more than two investment "reversals" (the first sell after a buy, or vice-versa) in any rolling one-year period. That?s lower than the 83 percent scored for mutual-fund holders, but still evidence, says Vanguard, that the temptation to trade is not the threat it was cracked up to be "and is not a significant reason for long-term individual investors to avoid using appropriate ETF investments as part of a diversified investment portfolio."

[See Target-Date Funds now Look Like Other Mutuals.]

While trading behavior of ETF holders was more active than that of those in mutual funds?27 percent of ETF positions were held short-term, compared with 12 percent for mutual funds?"more than 40% of the variation can be explained simply by correcting for differences in personal and account characteristics between ETF and traditional fund shareholders," reported Vanguard. The temptation effect does explain part of the other 60 percent, the study concedes, though Vanguard?s own limits on trading mutual funds, as well as unknowable self-selection effects whose impacts are indeterminate, also matter.

This is probably a good place to acknowledge that Vanguard has some skin in this game: It offers 49 ETFs, and presumably isn?t inclined to discourage folks from buying them. And, as Vanguard concedes, there is probably an element of self-selection at work, in that the sort of people attracted to Vanguard?practically a synonym for "buy-and-hold"?could be less prone to active trading than the overall investor population.

Vanguard notes, however, that a fund family which attracts more-active investors to its ETFs will likely attract them to its mutual funds, too. The whole point of the Vanguard study, says co-author Joel Dickson, is to document "relative trading activity"?namely ETF activity relative to mutual-fund activity?and to suggest that "the investment vehicle is not the source of that churn difference. just because it?s an ETF doesn?t mean an investor?s DNA automatically changes."

Source: http://epou.net/?p=42076

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