Investors’ behavior penalizes growth

The U.S. stock market enjoyed a major bull run in the second half of the 1990s, with the S&P 500 Index climbing an average of almost 29 percent per year between 1995 and 1999.  However, it appears that the average investor did not reap much of that reward, says John Bogle, former chairman of the Vanguard Group, a major mutual fund company.

In comments made to the Financial Industry Regulatory Authority last year, Bogle said investor returns on mutual funds during and after this period were much lower than the gross returns of the funds themselves.  Bogle selected the 200 U.S. stock funds that attracted the most money from investors during the 1990s bull market.  Then he tracked their returns from 1995 through 2005, a period that covered the bull market, subsequent bear market, and recovery.  The
return of the average fund was 8.9 percent per year over the 10-year period.  But a second calculation that took into account the cash flows into and out of the funds produced a dollar weighted return of only 2.4 percent.  This was the return earned by the average investor during the period, Bogle said.

Bogle blames this phenomenon on two investor behaviors, along with callous marketing by the funds. First, many investors made timing errors when investing during the bull market.  When stocks were cheap, during the period from the late 1980s to the early 1990s, cash flows into stock funds averaged only $10 billion a year. At the peak of the bull market from 1998 through 2000, $500 billion a year poured into stock funds.

A second mistake was made in the selection of a fund for new money.  Investors put most of the new money they invested at the height of the bull market into technology and Internet funds.  These were the funds that had already appreciated the most during the bull market and that were hit the hardest in the subsequent bear market.

Finally, mutual fund companies played a role by marketing ?hot? growth funds aggressively during the bull market and for advertising the high returns funds were earning.