Volatility can derail even the best client planning

Volatility can derail even the best client planning

While investors may express commitment to a long-term view, all too often volatility can have a negative impact on behavior and turn potential gains into losses.

This common response to uncertainty is demonstrated clearly in DALBAR’s 2012 Quantitative Analysis of Investor Behavior. In the study, DALBAR found that while the Standard & Poor’s 500 Index gained 2.12% in 2011, the average stock fund investor lost more than twice that amount.

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The reason for the underperformance, according to the study, is that equity investors were driven by last year’s volatility to cash out of their holdings. “This fear-driven activity took place primarily after down swings and led investors into cash that offered virtually no return.” (DALBAR) Last year’s markets continued a trend of higher volatility that began with the financial crisis. In fact, daily price changes in the S&P 500 Index over the past five years have been significantly more volatile than in the years leading up to the crisis.

DALBAR’s data reflect a persistent theme in investor behavior that behavioral scientists note can derail even the best client planning: selling off investments in response to negative macroeconomic news and market volatility. The firm’s research shows that over the past 20 years, on average, investors have held stock funds for only 3.29 years and fixed-income funds for only 3.09 years before selling — too short a time to reap longer-term market performance.

 

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Of course, many of the macro risks that drove volatility in 2011 remain, and the economy has not escaped the secular pressures brought on by the still-deflating global debt bubble. Investors and advisors may look to the higher holding period of asset allocation investors when considering how to address the adverse effects of volatility, recognizing that investments designed to lower volatility or mitigate its impact on returns may help investors hang on longer.

* Average stock investor performance is calculated by DALBAR using data supplied by the Investment Company Institute. Investor returns are represented by the change in total mutual fund assets after excluding sales, redemptions, and exchanges. This method of calculation captures realized and unrealized capital gains, dividends, interest, trading costs, sales charges, fees, expenses, and any other costs, After calculating investor returns in dollar terms, two percentages are calculated for the period examined: Total investor return rate and annualized investor return rate. Total return rate is determined by calculating the investor return dollars as a percentage of the net of the sales, redemptions, and exchanges for each period.

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