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Not every bond fund investor loses money over the long haul. But the Dalbar 20-year studies of investor behavior (linked below) clearly document that the average investor in fixed-income mutual funds never achieves real rate of return when even the government’s inflation numbers are subtracted, much less when taxes are paid on gains and a realistic rate of inflation is subtracted.

The quantitative analysis part of the report shows improvement of returns for investors as compared to the numbers reported in 2009, but the numbers will shock most investors. For the 20 years ending December 31, 2009, investors' annualized returns by fund type were: equity 3.17%, fixed income 1.02%, and asset allocation 2.34%. All returns are before an inflation correction of 2.80%, which leaves investors with 20 years real equity annualized return of 0.37% and negative annualized returns for fixed income of -0.78% and asset allocation -0.46%. [emphasis mine]

Why is the average bond fund investor so incompetent?

Here is a list of explanations offered by DALBAR that summarizes the reasons for the poor performance. The list draws heavily upon the behavioral research emerging science. It appeared in earlier editions of the annual QAIB report and is reproduced below.

(1) Loss Aversion: Expecting to find high returns with low risk.
(2) Narrow Framing: Making decisions without considering all implications.
(3) Anchoring: Relating to the familiar experiences, even when inappropriate.
(4) Mental Accounting: Taking undue risk in one area and avoiding rational risk in others.
(5) Diversification: Seeking to reduce risk, but simply using different sources.
(6) Herding: Copying the behavior of others even in the face of unfavorable outcomes.
(7) Regret: Treating errors of commission more seriously than errors of omission.
(8) Media Response: Tendency to react to news without reasonable examination.
(9) Optimism: Belief that good things happen to me and bad things happen to others.

What could be done to correct this problem of under-performance?

The simplest solution --and the one that Dalbar self-servingly suggests-- is that those “average” investors ought admit their persistent incompetence and find a financial advisor. But it can be inferred from Dalbar's own numbers that advised money offers only marginally better returns, instead of the market-beating, index-beating returns that that most investors need if they aren’t to suffer poverty in retirement. Obviously, “most” investors can’t be better than average. But a determined few could be, and the characteristics needed to achieve that superior performance have studied in detail by Schwager and others. If you’re not already part of the market-beaters club -- but want to become a member -- you’ll figure out how to benefit from the easily found research, which comes down to two things:

- A passion for the game
- A commensurate work ethic.

In short, those who do well like what they're doing. They've found an investing/trading game for themselves that exactly matches their temperament and personality, and then they stick to their plan.

Here's an 11-minute summary of Jack's original 53-minute lecture (that seems to have been pulled from YouTube)
Here's a 5-minute snippet from a longer talk by Linda Raschke.
Here's a 6-minute video by Van Tharp on personality

In all of those talks, feel free to substitute to term 'investor' for 'trader' for there being no material difference in terms of how both have to identify and manage their risks. What you will notice, however, is that all three talks emphasize the same things of matching your system to who you are, and the huge amount of work that has to be done to achieve success. That is why the "average" investor fails. (1) They're trying to borrow someone else's system --generally the garbage known as 'Modern Portfolio Theory' [sic]. (2) They are skimping on the time that achieving investing success requires. If you're willing to work "40 for the man", you ought be wiling to work "at least 4 for yourself". There's a whole bunch of investing things that can't be done successfully by putting in just 4 hours per week. OTOH, there are some games that can be found if that's all the time you have. So find an investing/trading game that is within your means and resources, and then go for it with as if you really do intend to win.


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