You have probably heard about what’s known as the DALBAR effect. It’s the fact that, as a group, mutual-fund investors underperform the funds in which they invest.
Quick background: The reason for this effect, amply documented over nearly a quarter-century by a Boston research firm, is investors’ behavior.
In short, mutual fund shareholders tend to buy and sell based on their emotional reactions to bull markets and bear markets, real or expected. Their timing is usually wrong, and in the end they would have done better by buying and holding.
(For a more detailed look at this effect, check out this article.)
OK, here’s the bad news: If you’re average, chances are you will underperform the funds that you own.
But here’s the good news: I’ve discovered a group of investors who are apparently doing just the opposite: They are outperforming the funds they own.
To understand how that’s possible, you’ll need to bear with me as I walk through some steps. For your patience, you will be rewarded at the end with my suggestion for how you too may be able to perform what seems to be a minor financial miracle.
I first discovered this anomaly while I was comparing target-date retirement funds offered by Fidelity and Vanguard.
What I found is more than just coincidence: It appears in the latest 10-year performance results in four pairs of retirement funds — those with target dates of 2020, 2030, 2040 and 2050.
Let’s take the Vanguard and Fidelity 2020 funds as examples. The numbers are clear on two points.
- The Vanguard fund has higher returns.
- While investors in the Fidelity fund (consistent with the DALBAR effect noted above), achieved lower returns than those of the fund itself, investors in Vanguard’s 2020 fund achieved higher results than the fund.
Here are the numbers:
For the 10 years ended March 31, 2017, the Fidelity 2020 Freedom Fund
compounded at 4.47%, while investor returns (provided by Morningstar Inc.) were only 3.13%. The Vanguard Target Retirement 2020 Fund