DALBAR QAIB 2008

DALBARThe Measurement of Success

© 2008 DALBAR, Inc.

DALBAR, Inc.Phone: 617-723-6400

Federal Reserve Plaza600 Atlantic Avenue

Boston, MA 02210www.dalbar.com

Compliments ofRuss Thornton

Thornton Wealth Management

QAIB 2008Advisor Edition

Extract ofQuantitative Analysis of Investor Behavior 2008 ©

What investors really do ... and how to counteract it.

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Compliments of Russ Thornton

Past performance is no guarantee of future results.

Introduction & Background

DALBAR's Quantitative Analysis of Investor Behavior (QAIB) has beenmeasuring the effects of investor decisions to buy, sell, and switch intoand out of mutual funds since 1984. The results have shown, to varyingdegrees, that the average investor earns significantly less than mutualfund performance reports suggest.

The goal of the QAIB study is to educate investors and the professionalswho advise them about the effects of investor behavior on the realfinancial outcomes of an investment program.

QAIB 2008 examines real investor returns for equity, fixed income, andasset allocation funds for the 20 years ended December 31, 2007. Whetherthe mutual fund industry is enjoying rapid expansion in times of economicboom, or is being battered by the bears, the key findings uncovered inDALBAR's first study from 1994 remain true: Investment return is farmore dependent on investor behavior than on fund performance.Mutual fund investors who hold their investments typically earnhigher returns over time than those who time the market.

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The Reality of Investor Returns

For years, mutual fund companies have been marketing their productsusing the long-term results of a lump-sum investment. The resultstypically show that the funds' annualized returns have outpaced theirdesignated benchmarks and inflation, implying that if investors purchasefund shares and hold them for similar time periods, they may achievesimilar results.

Reality, however, is quite different from this scenario - and it's not thefault of the fund companies. Based on an analysis of actual investorbehavior over the 20 years ended December 31, 2007, the average equityfund investor would have earned an annualized return of just 4.48% --underperforming the S&P 500 by more than 7% and outpacing inflation bya mere 1.44%. Fixed income investors would have fared far worse, losingtheir purchasing power by an average of 1.49% per year. Asset allocationfund investors would have done a bit better, beating inflation by 0.41%per year. Over shorter time periods, the results were far better for equityfund investors. 1, 2

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Average Investor Annualized Returns vs. Inflation

20 Years 10 Years 5 Years 3 Years 1 Year

Equity 4.48% 5.66% 12.51% 9.61% 7.13%

Fixed Income 1.55% 0.93% 1.33% 0.56% 1.09%

Asset Allocation 3.45% 4.06% 6.62% 4.83% 2.73%

S&P 500 11.81% 5.91% 12.83% 8.61% 5.50%

Lehman Aggregate 7.56% 5.97% 4.42% 4.56% 6.97%

Inflation 3.04% 2.67% 3.03% 3.35% 4.08%

Data sources: Investment Company Institute, Morningstar Associates and Lehman Brothers

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Why are investor returns so markedly different from what fund companiespromote? Likely because of the following two reasons:

● Investors attempt to time their investments and redemptions -- and arefrequently unsuccessful.

● Investor holding periods, on average, are shorter than the periodsmeasured by mutual fund companies.

Market Timing and the "Guess Right Ratio"

DALBAR's Guess Right Ratio measures how often the average equityinvestor correctly 'guesses' the direction of the market. In general, profitsare made when the Guess Right Ratio exceeds 50%, indicating thatinvestors must be right at least half the time in order to gain more than islost.3

An analysis of the 20-year period ended December 31, 2007, reveals thatequity investors were right more than wrong; however, the periods ofincorrect guessing had an impact on their portfolio (see chart, next page).Perhaps not surprisingly, the Guess Right Ratio was highest (at least 67%-- or 8 out of 12 months) during years when markets posted strongreturns and, with few exceptions, lowest during market declines. Theoverall Guess Right Ratio for the 20-year period is 61%.1

Interestingly, during the period of 'irrational exuberance' in the late 1990s,the Guess Right Ratio declined. Why? Perhaps because mutual fundinvestors, overconfident in the rising tide of the tech sector, guessedwrong as they moved assets away from the protection of diversifiedmutual funds and into direct investments in dotcoms and telecoms.

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Data sources: Investment Company Institute and Morningstar Associates.

A: Typically, when the market's on the rise.

Observation: It's easier to make the right decision when markets are risingand the fear of loss is on the back burner. The really smart decision is toinvest when the market is down.

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Buy and Hold? Not Necessarily

The second factor contributing to poor longer-term investor performance isa less-than-ideal holding period. Despite the industry's best efforts toeducate investors about the potential benefits of a long-term investmentperspective, equity shareholders typically sell their holdings in less thanfour years, while asset allocation fund shareholders may hold on foranother year or two. This indicates that regardless of their time horizonsand ultimate investment objectives (e.g., long-term growth), investorsmay not have the patience or emotional wherewithal to weather marketdips.1

Data Source: Investment Company Institute

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Systematic Investing Can Reap Rewards

How can investors better pursue long-term returns that are comparable tothe marketing messages? One way is by following a dollar cost averaging,buy-and-hold strategy. In all three types of mutual funds -- equities, fixedincome, and asset allocation -- the dollar cost averaging (or 'systematic')investor would have fared better than the average mutual fund investor.

● For equity investors, the increase in appreciation would have been morethan 50% (see charts, page 9);

● For fixed income investors, the increase would have been 196% (seecharts, page 10);

● And for asset allocation investors, the difference in return would havebeen 116% (see charts, page 11)!1, 4

Note all examples assume a total of $10,000 is invested over 20 years.

Observation: The illustrations on the following three pages demonstratethe importance of consistency in wealth building. Moreover, the benefit ofdollar cost averaging can potentially be dramatically improved byincreasing contributions over time.

"Start early, keep contributing, and don't panic."

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1Average stock investor, average bond investor, and average asset allocation investorperformance results are calculated using data supplied by the Investment CompanyInstitute. Investor returns are represented by the change in total mutual fund assets afterexcluding sales, redemptions, and exchanges. This method of calculation capturesrealized and unrealized capital gains, dividends, interest, trading costs, sales charges,fees, expenses, and any other costs. After calculating investor returns in dollar terms, twopercentages are calculated for the period examined: Total investor return rate andannualized investor return rate. Total return rate is determined by calculating the investorreturn dollars as a percentage of the net of the sales, redemptions, and exchanges for theperiod.

2The equity market is represented by the S&P 500, an unmanaged index of commonstock. The bond market is represented by the Lehman Brothers Aggregate Bond Index.Inflation is represented by the Consumer Price Index. Indexes do not take into accountthe fees and expenses associated with investing, and individuals cannot invest directly inany index. Past performance cannot guarantee future results. Data supplied by LehmanBrothers and Morningstar Associates, LLC.

3Note that this statistic is not dollar weighted so it cannot be used to measure returns.

4The systematic equity investor examples use the S&P 500, while the systematic bondinvestor examples use the Lehman Brothers Aggregate Bond Index. Data supplied byLehman Brothers and Morningstar Associates. Indexes do not take into account the feesand expenses associated with investing, and individuals cannot invest directly in anyindex. Systematic investing involves continues investing in securities regardless of pricelevels. It cannot assure a profit or protect against loss during declining markets. Pastperformance cannot guarantee future results.

DALBAR QAIB 2008

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