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Natural progression, increased regulation shaping markets

I can’t begin to count the new regulations that have come forth in the past few years regarding the investment industry. My personal experience would tell me that the average manager of a New York Stock Exchange branch would have four to five times more oversight responsibility than we had at the turn of the century. It’s easy to understand why this is happening. We have just survived the second worst bear market in a century and people are looking for someone to blame and a way to make sure it never happens again. It is, of course, an impossible task.

In a world market, everyone is to blame. Not just the President of the United States or scandal-ridden behemoths such as Enron and Worldcom or some trader at a mutual fund company that is allowing late trades after the funds have priced for the day. Everyone is to blame, including all those investors who convinced themselves that they deserved 30% a year on their stock investments and bought into a drastically overbought market in the late ‘90s and then sold out of the declining market when things were going badly.

Nevertheless, there is an attempt to regulate the industry out of this mess just as the natural progression of the markets is on the upswing anyway.

Regulations: the pros and cons

I’m not here to tell you that all of these regulations are bad. To the contrary, many have been beneficial to the process of managing assets. For instance, there are a number of regulations that you have or will see that require better disclosure of fees in our business. I believe in full disclosure, with the possible exception of the CIA, and I believe it will help investors understand what they are paying for.

However, there is a disturbing trend among regulators to always recommend that the lower the fee, the better. The claim of a number of regulators is that advice is incidental to the fee that is charged. When someone tells me that my advice is incidental to my relationship with my clients, I interpret that as meaning that my advice adds no value to the relationship. If that is true, then investors should do better by investing on their own and cutting out the cost of using a professional. Oddly, the numbers don’t agree with that philosophy.

The 2001 update of the Dalbar Study, “Quantitative Analysis of Investor Behavior” (QAIB), shows what happens when investors are left to their own devices. QAIB examined real investor returns from equity, fixed income, and money market mutual funds from January 1984 through December 2000.

This is Dalbar’s 25th year of producing results for this study, and even though the numbers have changed, the premise has always remained true. The average investor that does not seek help, significantly underperforms the market.
Investors in this latest study held their investments for an average of 2.6 years. That is an average that is less than the three year minimum our industry recommends that an investor hold a mutual fund. The average fixed-income investor realized an annualized return of 6.08%, compared to 11.83% for the long-term Government Bond Index. The average equity-fund investor realized an annualized return of 5.32%, compared to 16.29% for the S&P 500 Index over the same period of time. Remember that these numbers don’t include most of the last bear market. That’s why the figures are so high compared to today’s returns.

I hear experts every week who will tell you the average advisor-driven account will under-perform its corresponding index by just a bit, mainly attributed to the extra costs involved in hiring a professional. They tell you this as if those advisors aren’t worth hiring. Now investors are hearing from regulators in our own business telling them that advice in many cases is just incidental to the process. But when you look at the real numbers, you have to concede that given the opportunity to handle their own investments, the average investor will find a way to under-perform significantly.

Owning up to just average

One of the biggest hurdles investors have to jump through is admitting to themselves that they are average. It’s like driving a car; virtually everyone thinks they are a better-than-average driver.

I attended a seminar a few months ago where the speaker asked everyone who thought they were a better-than-average driver to raise their hands. Over 80% of the group raised their hands. I suspect that a question to a room full of investors would come out about the same when asked if they were average investors. It’s not hard to learn how to invest; however, it is immensely hard to invest your money well.

As you might have guessed, I am not one of those experts that believes you should save the money and do it yourself. I believe that the goals you are trying to reach are much too precious to be left to amateurs. I do believe that you should watch what you pay for your investment advisory services.

However, I think many of you should admit that you are average or below when it comes to driving your own investments and ask yourself if you can really afford not to have a chauffeur.

Contact MBJ contributing columnist Scott Reed, CIMA, CWA, AIF, of Hilliard Lyons, member NYSE & SIPC, in Tupelo at mbj@msbusiness.com.


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