When Investment Returns Are So Bad They Make GICs Look Good
The research firm DALBAR has been studying the behaviour of mutual fund investors for 25 years. Each year the firm reports how poorly investors fared relative to their benchmark index over time. What the data repeatedly shows is a ‘behaviour gap‘ that leads to significant investor underperformance.
It suggests that investors lack the patience to stay invested in any one fund for longer than four years. Furthermore, investors make ill-timed choices, invariably chasing last year’s winners while dumping what they perceive to be underperforming funds.
Why are investment returns so bad?
The chart below shows the annualized returns for equity mutual fund investors compared to the S&P 500 over 1, 10, and 30 year periods.
| Equity mutual fund investors | S&P 500 | Difference | |
| 30-year period | 4.1% | 10.0% | (5.88%) |
| 10-year period | 9.7% | 13.1% | (3.46%) |
| 1-year period | (9.44%) | (4.4%) | (4.35%) |
Now, I’m the first to rail against the mutual fund industry for charging high fees and failing to protect investors from unscrupulous advisors. Those practices do lead to poorer returns and do nothing to help investors achieve better outcomes. But studies like this show that investors are mostly their own worst enemy.
I also thought the panacea for investors was indexing. Just dump your high-fee mutual funds and switch to a low fee, globally diversified portfolio of index funds or ETFs. Make regular contributions, but otherwise leave it alone for your entire investing horizon. Problem solved.
But clearly that’s not working, either. Investors, even passive ones, are constantly looking to fine-tune their portfolio and tinker with what should be a good-enough solution.
We have access to more information than ever before, including the ability to trade on that information. What we really need is the ability to lock up our long-term investments in a way that prevents us from doing something we’ll regret.
Intuitively, DALBAR suggested that the much maligned variable rate annuity (a high-fee insurance product sold in the U.S.) acted in such a way that investors in variable annuities outperformed mutual fund investors, despite the higher fees.
An all GIC solution?
DALBAR’s odd solution reminded me of an article I wrote more than six years ago about using an all GIC portfolio. This controversial savings strategy was popularized by accountant and author David Trahair.
He suggested that most Canadians were better off forgoing any investing until their mortgage was paid off. Once mortgage-free, Trahair says to ramp up your savings rate but avoid the market and stick to ultra-safe GICs.
The downside of an all GIC approach is inflation – if you’re just treading water at 2-3 percent then you’re going to need to save a lot more money than if you were potentially earning 6-8 percent in the market.
The idea seems counterintuitive until you look at the data. Actual investor returns underperform so badly that some of us would be better off avoiding market and behaviour risk altogether and opting for the guaranteed return.
It’s a strange concept, especially for readers of this blog. After all, my own portfolio is made up of 100 percent equities and I preach staying the course with a long-term index investing strategy.
But is it that strange for the vast majority of investors? You know, the ones making these egregious behavioural errors and constantly shooting themselves in the foot? How many are actually making themselves poorer simply by trying to invest?
A behavioural problem
I often write about credit card rewards and the first rule of earning rewards is that you pay off your balance on time and in full, without fail. It’s such obvious advice that it often goes unsaid. It’s foolish to try to earn 2 percent back on your spending if you’re paying 19 percent interest on an unpaid balance.
Yet Canadians carry an average credit card balance of $4,154. We’re obviously not getting the message when it comes to controlling our behaviour.
Investing seems to be no different. We all know to buy low and sell high. Yet the studies show we’re doing the opposite. We all know to ignore the pundits and headlines – it’s the long-term that matters most. But, again, we can’t help checking our portfolio balance during a market meltdown. Worse, we make changes to a perfectly sensible portfolio based on useless economic predictions that rarely come to pass.
Final thoughts
So, what to do when investments returns are so bad they make GIC returns look good? Switch to an all GIC portfolio? Nah. Not for intelligent blog readers like yourselves.
Reports like this are a good reminder to make sure you have an investment policy statement – the ten commandments, if you will, that guide your future investment behaviour. A few, thou shall nots, should suffice.
As perverted as it sounds, the mutual fund industry will use this study to preach the benefits of deferred sales charge (DSC) mutual funds that lock-in investors for a period of 5-7 years with high redemption penalties. I don’t buy it.
My takeaway from the DALBAR report is that advisors need to focus less on selling investments and spend more time on financial planning. Investors with an appropriate portfolio don’t need to hear about the latest hot sector or region in which to invest. The very idea is counter to a long-term, globally diversified approach.
Accept market returns, minus a small fee, and get to work on improving other aspects of your finances, such as retirement planning, estate planning, assessing your insurance needs, and increasing your savings rate.
You’ll improve your investment returns simply by leaving your portfolio alone.
Well clearly there must be alot of Canadians buying GIC’s as the last time I heard it was about $900 billion. I would say to Canadians that if people are loading on GIC’s at least have them in tax sheltered, tax free plans.
RRSP’s, RESP’s, RDSP’s, LIRA’s, LIF’s, TFSA’s are all good examples of keeping the taxation of interest sheltered or tax free. However, even a small percentage say 30% to 35% of an entire overall portfolio would be helped by a mix of blue chip type equity, stock market investments like utilities, banks, insurance companies, real estate and related like REIT’s, mortgage type of investments.
I am a new reader to your blog and ironically came across this topic. I am 48, with a paid off house and cottage and currently hold about $650,000 in RRSP, TFSA and company pensions between my wife and I, hoping to call it a day in the next 5 years or so. With the exception of funds within our company pensions, we are 100% GIC investors and quite happy about it. It all comes down to comfort level. For us, the guarantee of not losing money on an investment, even if earning a lower rate gives us peace of mind. We just understand that some over saving is an essential part of our FIRE plan. A GIC tool that we put 80% of our non pension investments into are index/Market growth GICs. No risk of loss, but a chance at higher than normal fixed rates at the end of the term. Not as high of return from when they first started becoming available, but over the past 10 years, we are averaging about 4.5% return during times of 1 – 2 % fixed returns, while not losing any principle. Again, its all about comfort level and any plan can work if you adjust to make it work. Enjoy the Blog. Bill
Bill B Gone, we are in a similar situation but we are both in our late 50’s and use only fixed rate GIC’s with compounding that interest for more growth. We don’t have any company pension plans but we do have RRSP’s of $1,224,000 and $155,000 in TFSA’s. We have laddered regular cash GIC’s of $15,000 a year for 10 years. Our reserve, emergency fund of 1 years worth of $40,000 is high interest savings account.
Basically, we always shopped around for GIC’s that pay fixed interest rates and go longer term 5 to 10 years CDIC, DICO, DGCM. Interest rates have dropped now but we invested quite mostly 90% 5 to 7, some 10 years in 3.3% to 3.75% rates the first 6 months this year. We are using a floor strategy to protect our guaranteed income in retirement from falling interest rates.
The highest 4 and 5 year GIC I could find is 3.0% for Oaken, 3.0% for 5 years ICICI Bank of Canada with CDIC insurance. As for 3 year GIC’s 3.0% average for Meridian C.U. with 2%, 3%, 4% step-up or escalator GIC.
Westoba C.U. has 2.8% for 7 years and 2.9% for 10 years. Duca C.U. has 2.9% for 7 years, Accelerate Financial has 7 years for 2.9%. There are many places on the web you can find highest rates as they can change everyday.
We will be retiring next year at 60 and get our C.P.P. early which will be $18,500 a year and small retirement bonuses of $10,000 each as we work at the same company for 26 years now which will be used for future income needs. We will live off our laddered GIC’s and C.P.P, OAS until we are 65 and get probably another $1,300 a month in OAS.
Also, being 100% debt free and a modest house paid off easier to keep, maintain with no mortgage plus lower property taxes, home insurance, utility bills to pay for. Everyone has a financial strategy, plan they are comfortable and works for them. Good luck and happy retirement hopefully soon for you and your wife in 5 years.
I’d suggest looking into how DALBAR calculates this behaviour gap before believing any of their numbers.
I’m aware of the criticism (Pfau’s specifically), along with Dalbar’s response: https://www.thinkadvisor.com/2017/04/20/lou-harvey-hits-pfau-back-over-criticism-of-dalbar/
Do you believe the investor performance is understated? And, if so, by how much?
Investor performance is definitely understated by Dalbar. By how much, I don’t know, because I don’t have the data they use. I wrote a long post trying to explain the problem with Dalbar’s methods:
https://www.michaeljamesonmoney.com/2018/01/dalbars-measure-of-investor.html
The main problem is that Dalbar is essentially criticizing investors for not having new money to invest early enough. If they are measuring performance over a decade, but you added new money 5 years ago, they punish your measured return for not having this money available to invest at the beginning of the 10-year period.
Isn’t anyone really concerned about another 30% to 50% drop in stock, equity markets and what about real estate markets. I don’t think the next recession will be able to be fixed with more debt, lower interest rates and any other new age monetary trickery governments and central banks have.
My long time friend had to go back to work after only 3 years retiring because his stock portfolio and income was cut by 30% from income trusts and mutual funds. GIC’s paying only 2.3% to 3.0% is not great but losing 30% or more is really terrifying. This is especially true when you don’t have a weekly or bi-weekly paycheck coming in anymore.
It is a real shame how savers are getting really low interest on their savings accounts and GIC’s, term deposits. It just looks to me that they are making it more difficult for responsible people and there is nobody standing up for the little guy or little people. Will we ever see 4% to 5% normal interest rates again on savings, GIC’s as average inflation is 2.5%+ a year at minimum.
I agree Linda. It can be very frustrating. Rates are kept low to help keep the economy moving by encouraging people to spend money they don’t have. The savers get punished with extremely low rates if they want to be safe. It is forcing people to become gamblers or fall behind. Something seems wrong with this process. You are correct, even 4% would make the world of difference for those who prefer the peace of mind of safe investing. Cheers!
3% for 5 year GIC’s is the best it gets right now and it looks that it won’t last too long too. It will be more 2.25% to 2.5% in the next 12 months, so sad.