ProFutures Investments - Managing Your Money

July 22, 2003


1.  Results Of The Latest Dalbar Study On Investor Returns.

2.  Investors Make A Fraction Of What Market Indexes Return.

3.  Emotions Cause Investors To Buy High And Sell Low.

4.  The Solution: Use Professionals To Manage Your Money.

Taking Emotions Out Of Investing

The results are in: investors are still trying to time the market on their own, and realizing much less than market returns in the process.  How do I know?  A recent press release by Dalbar, Inc. updated their Quantitative Analysis of Investor Behavior first issued in 1995.  This most recent update continues to show that individual investors are not realizing anywhere near market rates of return in stocks and bonds because of frequent switching among “hot” mutual funds and trying to time the market.

When I first became aware of the initial Dalbar study back in 1995, I honestly didn’t believe it.  It also came as quite a shock to the investment industry.  After all, the mutual funds had been preaching “buy-and-hold,” and even to buy more when market corrections occurred (also known as “buying the dips.”)

In this issue of the Forecasts & Trends E-Letter, I will discuss the findings of the latest Dalbar study update, as well as ways to avoid becoming a Dalbar statistic.  I’ll conclude by discussing the merits of market timing using professional money managers.

The 2003 Dalbar Study Update

I wrote about the Dalbar organization previously in my “Mutual Fund Merry-Go-Round” series of E-Letters ( January 28th, February 11th, and March 11th).  To recap, Dalbar is a Boston-based financial services research firm that provides a number of services to the mutual fund and brokerage industries.  On July 15, 2003, a Dalbar press release updated their Quantitative Analysis of Investor Behavior (QAIB), originally released in 1995.

In its latest press release, the QAIB updated the original study to include performance information for the period from January of 1984 through December of 2002 (19 years).  The update continued to support the findings of the original study: the average mutual fund investor is not getting returns equal to those in the market.  The latest QAIB update contains the following statistics:

The average equity fund investor earned only 2.57% annually over the 19-year period included in the study, compared to annualized inflation of 3.14% and the S&P 500 Index average annual return of 12.22%.  (Yes, you read it right.  The average mutual fund investor’s gain was less than inflation over the last 19 years and only a fraction of what the S&P 500 gained!)
The average fixed income (bonds) mutual fund investor fared a little better, but not up to the market’s performance.  Over the last 19 years, the average fixed income mutual fund investor had an annualized gain of 4.24% versus the long-term government bond index which averaged 11.70%.

Keep in mind that the Dalbar studies look at the “average investor” in mutual funds.  They do this by analyzing mutual fund inflows and outflows to arrive at their estimates for how the average investor did.  Not everyone fared so poorly, and some did even worse.  For example, if you bought a good S&P 500 Index mutual fund 19 years ago and held it, then you should have done as well, or about as well, as the S&P 500 Index which averaged over 12.2%.  Some investors did just that.  Or if you bought a good long-term T-bond fund 19 years ago and held it, you should have made apprx. the 11.7% noted above.  Again, some investors did just that.  Unfortunately, most investors did neither.

The whole point of the Dalbar studies, and others like them, is that most investors DON’T buy-and-hold for long periods of time.  Most investors get into and out of the market, usually at the wrong times, and they frequently switch funds trying to chase the top performers.

Investing On Emotion

As I said above, when I originally became aware of this study back in 1995, I could not see how a reasonable investor would jump out of a fund just because of a temporary loss, only to move into the latest “hot” fund and then see it lose as well.  Even after other studies became available that agreed with Dalbar, I still found it hard to accept their results.

Only after writing a newsletter article to my clients about the Dalbar study did I discover that many investors aren’t reasonable, they’re emotional .  Some of my own clients told me that it sounded as if the Dalbar study had been written based on their experience in managing their own investments.

To be honest, I was shocked.  After all, my clients were largely high net worth individuals who had invested in sophisticated proprietary funds with my company.  Surely, I thought, these experienced clients would not be having the same problems as the “average investor” with the money they managed on their own.  But the message was clear: we need help with our mutual fund investments.  When I heard that message, it prompted me into action.  More on that later.

One Study, Three Alternative Courses Of Action

The stated conclusion reached by the Dalbar study is that market timing doesn’t work.   I should point out that in Dalbar’s context, market timing refers to individual investors who try to time the ups and downs in the stock market by getting into and out of mutual funds.  As I will point out later on, there are professional Investment Advisors who have successfully timed the markets, so market timing can work if done properly. 

Anyway, in their latest report, 19 years of evidence shows that most investors are their own worst enemies when it comes to reaching their financial goals.  They often buy when the markets are hot, only to get frustrated and sell when the markets are down.  Most investors would have been far better off if they had adopted a “buy-and-hold” strategy – and actually held it – over the last 19 years during the greatest equity bull market in history.

I will be the first to agree that a buy-and-hold portfolio works well if you can actually select superior securities, and then actually hold onto them when inevitable market downturns and losses periodically occur.  After all, this is the rational, reasonable thing to do in light of a mountain of evidence that buying and holding investments for the long term maximizes performance.

The only problem is that, unlike Mr. Spock of Star Trek fame, humans are not entirely rational beings.  We cannot neutralize all of our emotions when it comes to investing.  An investor may know that it is best to hold onto an investment in downturns, but actually doing it is a different story.  Some investors worry so much about investment losses that they literally become ill or can’t sleep at night.

The result?  Investors sell the losing investment, usually at the wrong time, and try to find something that is working better.  After all, there are lots of magazines and financial news shows touting the latest top-rated mutual funds.  By selling and jumping from one hot investment to another, the investor becomes what I call a “Dalbar statistic.”

If most investors cannot separate emotions from their investment decisions, then what is the solution?  One way to approach this inherent investor weakness is to seek the advice of a professional money manager or financial planner.  Many times, having a calm, rational Advisor to talk to can prevent assets from being liquidated at the wrong time.

Unfortunately, this option is only as good as the Advisor you select.   During the recent tech bubble, many brokers and financial planners were recommending that their clients stay in vastly overvalued securities, and the result was carnage in the market.  Thus, it is important to check out the credentials of any investment advisor that you use, whether it be a stock broker, insurance professional, Certified Financial Planner or Registered Investment Advisor.

Even with a qualified Advisor, it is still up to the investor as to whether to take the advice, or liquidate the investment.  Committing to a pure buy-and-hold portfolio strategy means that, at one time or another, you’ll be fighting your own human nature to hit the exits when losses occur.  As Dalbar documents, this is a fight that most investors lose.

In the spirit of full disclosure, my company offers an asset allocation program called the Dynamic Allocation Program that recommends a buy-and-hold portfolio of top-rated mutual funds.  Therefore, I know first-hand how hard it is for many investors to hold onto buy-and-hold positions when the market is going down.

Building A Better (Market Timing) Mousetrap

Some investors review the Dalbar study results and conclude that the average investors described are just that – average.  Many who deem themselves to be “sophisticated investors” agree that jumping out of the market based on emotion is unwise, but also feel that they can develop their own non-emotional timing system for moving in and out of the market.

As I will discuss later on, building a better market timing system is difficult, even for the professionals.  However, I have also talked to individuals over the years who have successfully developed their own market timing methodology, so it’s not an impossible task.  The most important thing to remember is that market timing doesn’t necessarily aim to “beat the market,” but rather seeks to participate in up markets and minimize losses during corrections and bear markets.

If you feel that you are not emotionally cut out to ride the buy-and-hold roller coaster and want to develop your own market timing system, you will need some help.  I have written a Special Report entitled “Secrets of Successful Market Timing” that discusses the things you need to know to develop a successful market timing strategy.

The primary advantage to developing your own market timing system is that it takes the emotion out of entering and exiting the market.  If you can develop a methodology that you can trust to work in all kinds of market conditions, and have the discipline to follow its signals, then you shouldn’t become a Dalbar statistic.  Building your own system also has the added advantage of avoiding professional money management fees.

One of the major disadvantages that I see in developing your own market timing approach is that building such a system is a tall order.  I know many individuals and professionals who have come up with a system that works for a while, but then the wheels fall off when the market environment changes.  You need to be aware that a market timing system that cannot adjust to fit many different market conditions can result in greater losses than a buy-and-hold strategy.

Another disadvantage of timing the market on your own is that it will take a lot of your time to develop the methodology, and then to monitor all of its essential elements and execute trades on a periodic basis.  Market timing is considered an “active management” strategy because it usually requires some level of daily monitoring and/or activity to be successful.  This, in turn, means that you have less time for your other work, family, recreation, social obligations, etc.

I learned early on that developing my own market timing system was not for me.  I have two young children (ages 11 and 13) whose activities have always kept me plenty busy, and I wouldn’t want to have missed a minute of it.  If you don’t feel you have the ability or the time required to develop and implement your own market timing approach, read on – there is another solution.

Professional Market Timing Solutions

There is an entire industry that believes that, while the findings of the Dalbar study are correct, the conclusion is generally flawed.  Professional market timing money managers believe that there is a way to participate in good markets while also limiting exposure to down markets.  While no particular system is perfect, a market timing system that has a proven record of limiting losses can also help to take the investor’s emotions out of portfolio management.

I have written often about market timing strategies and professional market timing Advisors, so I won’t repeat what has already been said.  However, I will stress some points that are important to consider when evaluating any market timing Advisor.

First, like any other profession, many Advisors are not very good, most are mediocre, and just a very few are really outstanding.  The key is how to tell the difference.  During the recent extended bull market, there were many Advisors who thought they were good, but were actually just in the right place at the right time.  The recent bear market has laid to waste many of these Advisors’ systems, especially those based on market data taken only from the bull market years.

When reviewing the investment programs of a market timing Advisor, it is important to keep the following key points in mind:

*          The Advisor should have an attractive performance history as compared to various market indexes.   This should be an actual trading history, and not simply the results of “back-testing.” 

*          It is also important to recognize that market timing systems are not necessarily designed to beat the market indexes, but seek to limit the losses during down markets.  If an Advisor’s program has historically reached a level of returns that meets your financial goals, and has done so with less risk than the overall market, then it’s OK if that program doesn’t beat all of the major market indexes.  Remember, limiting losses is the most important element.

*          The Advisor should have experience managing money in both bull and bear market conditions.  That’s not too hard to do now that we have gone through a three-year bear market in stocks.  However, be wary of new programs that have only managed money during the bear market and have posted impressive gains by shorting the market.  They might lose it all when the market turns around.

*          The Advisor should have a sophisticated, time-tested system for selecting investments and forecasting the market, and a disciplined approach to following the system.  Occasional discretion is OK in some systems, but you wouldn’t want to go with an Advisor whose only system is his or her “hunch” about the market.

*          The Advisor should have an experienced staff and efficient procedures to handle the back-office tasks associated with account processing and trading.  The best system in the world is worthless if the trades cannot be made effectively.

*          The Advisor should have a clean regulatory history and stable business practices.  Ask lots of questions, and be wary of any professional Advisor who is evasive or becomes angry.

Finding The Good Ones Is Not Easy

Unfortunately, finding information on professional market timers is a challenge because Advisors are not required to report their results.  Thus, there is no single database that lists all professional market timers and their performance.  My company recommends market timing Advisors to my clients, so we subscribe to various different databases for market timing performance information, and we still don’t have access to all of them.

One of the best sources for both professionals and individual investors is the Society of Asset Allocators and Fund Timers, Inc. (SAAFTI), a professional organization of active money managers.  My company is a member of SAAFTI, as are many other Advisors who either provide active management strategies, or recommend them to clients.  You can find more information about SAAFTI and its membership at

Another excellent source is the MoniResearch Newsletter edited by Steve Shellans (800-615-6664).  MoniResearch tracks a more limited number of Advisors, but actually provides verified performance results rather than allowing self-reporting by the Advisors.  In the July/August edition of the newsletter, Shellans reports that 70% of the Advisors tracked by MoniResearch outperformed the S&P 500 Index, and 100% outperformed the NASDAQ Index over the last three years ended June 30.  That’s impressive!


The Dalbar study shows us the danger of hopping from one mutual fund to another, chasing the latest “hot” performance and trying to time the market.   However, fighting the human nature to escape losses can be difficult, if not impossible, for many investors. 

One way to potentially minimize the effect of market losses is to seek out market timing strategies that have historically moved to the safety of cash, or even gone “short” during market corrections or bear markets.  You can attempt to develop a market timing system on your own, but my advice is to stick with professional Advisors for the best results.

Fortunately, investing is not an “either/or” situation.  You can combine both a buy-and-hold passive strategy and an active market timing strategy in your portfolio to potentially smooth out the extreme ups and downs inherent in a buy-and-hold only portfolio.  The original Dalbar study led me to develop my ADVISORLINK program where we continually search the investment industry for successful market timers.  This service has allowed my clients to introduce market timing strategies into their own existing buy-and-hold portfolios.

If you already have an extensive buy-and-hold portfolio, adding market timing strategies to the mix may provide you with the emotional support to weather the losses that will occur from time to time in the buy-and-hold portfolio.  The mix of active and passive strategies depends upon your financial goals, risk tolerance and investment experience.

Preparing For The Next Recession

In my July 8 issue of Forecasts & Trends E-Letter, I discussed the longer-term economic forecast from The Bank Credit Analyst, and it is not prettyIf you didn’t read it or want to review it again, CLICK HERE.  While the BCA editors are optimistic about the next 12-18 months, they believe that the next recession will be a serious one, whenever it occurs.  They believe it will be accompanied by a serious bear market in stocks.  If they are correct, you will need to be familiar with market timing strategies beforehand.

This is another reason why I am writing this series of E-Letters on Alternative Investments.  As the Dalbar studies have shown, most investors under-performed the market averages, even in the greatest bull market in history for stocks.  Imagine what will happen in a serious recession.

In closing, you can seek out professional Advisors on your own, or you can work with a specialty firm like my company, ProFutures Capital Management.   We will do the continuous searching and ongoing monitoring for you, just as we do for our clients all across America.  You can see more information at our website (CLICK HERE ) or you can call us at 800-348-3601.

Hoping you’re not a Dalbar statistic,

Gary D. Halbert


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