Alternative Title: The Gap Everywhere There exist many flavors of market timing.
Some are obvious:
In 1929, an influential businessman states that US Equities will return 24% per year for the next 20 years; or in 1999, a stock market forecaster predicts Dow Jones to double
On dollar-weighted basis, equity mutual fund investors under-perform buy-and-hold by 6.2% per year during the past 30 years.
ETFs investors under-performing buy-and-hold by -2.28% per year between 2010 and 2016.
Individual stock investors give up -1.3% per year between 1926 to 2002.
Market forecasting newsletters 1983-1995 don’t forecast.
Others are less obvious and more sophisticated:
Hedge fund investors realized a dollar-weighted 2.9% over a 28-year period, trailing buy-and-hold by 3.2%
Endowments returned 3.8% from 2009 to 2016 trailing 60/40 by 5.5%
Overall, the average asset owner GAP from this “quick and dirty” meta-study is -3.1% per year.
Yes, there has been some criticism (here, here, here, here) of how dollar-weighted returns are calculated, and it should be addressed. Nevertheless, investors are not surprised to see these results because their personal and anecdotal experience confirms them.
To me, the most surprising is the size of the Gap in total portfolios: 28,000 endowments lag 60/40 by 5.5% per year since 2009, and multi-asset mutual fund investors lag 60/40 by 6.8% per year since 1987. Are these results representative of the average asset owner’s total portfolio Gap?
Of course, the endowment Gap is not just a product of traditional short-term market-timing (here), but poor asset allocation decisions. However, asset allocation choices can be seen as just another form of trying to time the market over longer-horizons because just like short-term market timing, its main goal is still to avoid the drawdown risk.
Traditional investment professionals often struggle with IRR measure of return used in Private Equity industry. And while IRR’s do have their challenges, when properly modified, they could make traditional investors more accountable for the bad market timing decisions. Well-performing approaches and managers typically raise record assets at the peak of their performance, and then their performance deteriorates. IRR’s would capture this asymmetry and help guard investors against the common failures of asset allocation.
I wonder how large the Gap is for allocations to emerging markets, REITs, commodities, TIPs and MLP’s? And what about Risk Parity and Factor Investing?
Investors have become significantly more aware of the negative impact of high fees on their performance and hence the huge rise in passive investing and dropping fees. The cost of taxes has also been well understood producing various advances to mitigate it (tax loss harvesting, lower turnover, retirement and college saving plans, and variable life insurance solutions).
Yet today, I believe, the dollar vs. time weighted Gap still remains as the single largest unsolved ‘cost’ facing investors. (Ideas for solutions are welcomed in the comments).
PS. thank you Mike B. Fernandez for research assistance on this blog.
PS2. See the Newton’s Gap Problem in the 1720’s during the South Sea Bubble
PS3. See John Maynard Keynes’ Gap Problem in 1920’s
Evidence & Some Criticism of the GAP:
Barber, Brad M. and Odean, Terrance, Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. SSRN
Bogle, J. C. (2007). The Little Book Of Common Sense Investing: The Only Way To Guarantee Your Fair Share of Market Returns. Hoboken, NJ: John Wiley & Sons. Amazon
Braverman, Oded & Kandel, Shmuel & Wohl, Avi, 2005. "The (Bad?) Timing of Mutual Fund Investors," CEPR Discussion Papers 5243, C.E.P.R. Discussion Papers.
Dahiya, Sandeep and Yermack, David, Investment Returns and Distribution Policies of Non-Profit Endowment Funds (December 27, 2018). European Corporate Governance Institute (ECGI) - Finance Working Paper No. 582/2018; Georgetown McDonough School of Business Research Paper No. 3291117. SSRN
Dichev, Ilia D., What are Stock Investors' Actual Historical Returns? Evidence from Dollar-Weighted Returns (December 2004). SSRN
Dichev, Ilia, D. 2007. “What Are Stock Investors’ Actual Historical Returns? Evidence from Dollar-Weighted Returns." American Economic Review, 97 (1): 386-401.
Dichev, Ilia D. and Yu, Gwen, Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn (July 1, 2009). Journal of Financial Economics (JFE), Forthcoming. SSRN (2010 Revision Download) or Science Direct (2011 Revision Download)
Faber, Nathan (2017), Misattributing Bad Behavior, Flirting with Models.
Friesen, Geoffrey C. and Sapp, Travis R. A., (2007) Mutual fund flows and investor returns: An empirical examination of fund investor timing ability. CBA Faculty Publications.
Glassman, J.K., & Hassett K.A. (1999). Dow 36,000. New York: Times Business. Amazon
Goyal, Wahal, Yavuz, Choosing Investment Managers (2020) SSRN
Graham, John & Harvey, Campbell. (1997). Grading the Performance of Market-Timing Newsletters. Financial Analysts Journal - FINANC ANAL J. 53. 54-66. 10.2469/faj.v53.n6.2130. Research Gate
Hayley, Simon, Measuring Investors' Historical Returns: Hindsight Bias in Dollar-Weighted Returns (March 12, 2012). Midwest Finance Association 2012 Annual Meetings Paper. SSRN
Hsu, Jason, Myers, Brett, Whitby, Ryan, (2016) “Timing Poorly: A Guide to Generating Poor Returns While Investing in Successful Strategies”, The Journal of Portfolio Management Winter 2016
Keswani, Aneel and Stolin, David, Dollar-Weighted Returns to Stock Investors: A New Look at the Evidence (January 31, 2008). Available at SSRN
Kinnel, Russel (2018), Mind the Gap, Morningstar
Madhavan, Ananth and Sobczyk, Aleksander, Does Trading by ETF and Mutual Fund Investors Hurt Performance? Evidence from Time- and Dollar-Weighted Returns (April 5, 2018). SSRN
Odlyzko, Andrew, Newton’s financial misadventures in the South Sea Bubble, 2018, here.
Phalippou, Ludovic, The Hazards of Using IRR to Measure Performance: The Case of Private Equity. SSRN
Roberts, L. (2018). Dalbar (2017), Investors Suck At Investing & Tips For Advisors. Advisor Perspectives.
Samuel Crowther, "Everybody Ought to Be Rich: An Interview with John J. Raskob,» Ladies' Home Journal (August 1929). Copyright 1929, Meredith Corporation. All rights reserved. Used with permission of Ladies' Home Journal. Lincoln Public Schools