Dalbar publishes the Quantitative Analysis of Investor Behavior (QAIB) annually. In it, several claims are made, the most common of which is that the average investor consistently under-performs the market.

  1. How is it possible for the average investor to underperform the market? Isn't the market return the average of the returns on all shares of stock? Isn't every share sold by an investor sold to a different investor so the "average" investor always owns the same amount of stock in every company, since together, investors own 100% of the stock in every company?
  2. Does the study account for the return that the investor could be earning with the money they take out of the stock market? For instance, if it is used to pay down a 5% mortgage, the investor is implicitly making 5% and if it is used to start a business, the investor is making some return on the business venture.
  3. Does this result imply that markets are not efficient? Doesn't the fact that investors can consistently underperform the market by making poor decisions, imply that an investor could consistently outperform the market by making the opposite decisions?

Edit: A common response appears to be to suggest that "Average" here is population-weighted, not dollar-weighted. While this seems intuitive, it opens up two additional questions:

  1. Most institutional investors (banks, pensions, mutual funds) represent and pass on earnings to thousands or millions of individual investors? So, the "average joe" investor is actually part of several institutional investors. How would one account for this?
  2. How would the DALBAR collect the information on what the average investor does? Since individuals trade through brokers and don't want their trading info to be public knowledge, all DALBAR can see is the total bought and sold, not who did it. And DALBARs methodology doesn't seem to look at anything other than total volume, so how could they mean a population-weighted average?
  • Institutional investors are not considered "average", given that they could be on the other side of the transaction you have your answer to all your questions.
    – Pete B.
    Oct 31 '17 at 14:33
  • Note that underperforming the market does not necessarily mean losing money (title). It may only mean earn less. Oct 31 '17 at 19:42
  • "Does this result imply that markets are not efficient?" Efficient is an economics term. If you have questions about that term, you should ask on Economics.SE.
    – Brythan
    Oct 31 '17 at 21:45
  • @Brythan I assume the OP is referring to the Efficient Market Hypothesis which is very much a finance topic.
    – D Stanley
    Nov 20 '17 at 14:44

Median and mode are different

It appears that there's a confusion between the different types of average. Saying "the average investor" generally means the most common type of small-scale unsophisticated investor - the mode (or possibly median) investor. However, while this class of investors is numerous, each of them has assets that are quite small compared to some other types of investors; and the market average performance is determined proportionally to the amount of assets held, not to the number of holders; so the performance of large investors "counts" that much more.

For any measure, the mode of performance can be (and often is) different from the mean performance - in this case, Dalbar is saying that the most common results are lower than the (weighed) average results.


How is it possible for the average investor to underperform the market?

The "average" investor probably makes some bad decisions. You also might need to take transaction costs into play (including borrowing on margin), so that there's a natural "erosion" of returns across the market. Meaning if transaction/borrowing costs are 1%, and the market return is 5%, the "average investor"

Alternatively, if by "average" they mean the average of the population, not weighted by amount, it's plausible that the mass of smaller investors perform slightly worse than the smaller number of large investors (and have larger relative transaction costs), thus having a lower average on a per-capita basis.

Doesn't the fact that investors can consistently underperform the market by making poor decisions, imply that an investor could consistently outperform the market by making the opposite decisions?

No. If my investment decisions cause me to earn only a 10% return compared to the "average" 12% return, then making the opposite decision will cause me to lose 10%, not to make 14%.

  • 1
    The lag between market return and average investor is so large, expenses become tiny compared to the loss of the masses who buy high and sell low. Oct 31 '17 at 18:23
  • @JoeTaxpayer You're probably right; without any actual statistics I was more or less thinking of other factors that could contribute.
    – D Stanley
    Oct 31 '17 at 18:24
  • Transaction costs would in fact cause the average investor to underperform a market index. However, if that's all the DALBAR is measuring, it's rather uninteresting, since everyone knows that transactions have a cost. The population-weighted average makes more sense as an explanation, but then my question is: how would they measure that? Their methodology doesn't seem like it would capture that, since it seems they only looked at total volume bought or sold. Nov 20 '17 at 13:30
  • @KalevMaricq I cannot speak to the methods or resources Dalbar uses in their study, only to the questions regarding "average" investors underperforming the market. Are markets inefficient? Yes (I believe so). Do investors make imperfect, even irrational decisions? Yes (this has been proven).
    – D Stanley
    Nov 20 '17 at 14:51
  • @DStanley Understandable that you can't speak directly to the DALBAR methodology. Under your definition, the average investor could definitely underperform the market. I guess my question is, do we have any evidence that this is happening? I've heard DALBAR cited, which is why I focused on that, but I'm really wondering if there is anything showing that the average person actually does do worse than the market. Nov 20 '17 at 17:43

I think you are mixing two different concepts here. The average investor, in the quoted reference, means an average single investor like you or like me.

the average investor consistently under-performs the market.

However, you then ask the question and you seem to refer to all investors as a group; individuals, institutions, investment banks, et al.

since together, investors own 100% of the stock in every company?

Every investor could match the performance of the market easily and at low fees by simply buying an S&P index fund and holding it. In fact, some investors can even beat the market with the addition of some stocks. Here is the ten-year chart of Berkshire-Hathaway B compared to the S&P 500.

enter image description here

There are other examples.

However, few of us have the discipline to do so. We read questions here every week about the coming turbulence in the market, about the next big trend, about the next bubble, etc. The average investor thinks he is smarter than the market and buys on a whim or sells likewise and misses out on the long, slow overall growth in the markets.

Finally, the title of your question is “Dalbar: How can the average investor lose money?” I doubt that the average investor loses money in the past several years. Not making as much money as is easily possible is not at all the same as losing money.


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