Amateurs Beat the Investment Pros

Vanguard just released its 2009 How America Saves study and it provides some interesting data on how individual 401(k) investors seem to have handled this financial crisis much better than the institutional investors who manage big pension plans and endowments.

Losses. According to the Vanguard study (which covered 3 million investors), Vanguard 401(k) participants had a median account balance decline of about 14 percent in 2008. Now, this calculation includes cash from ongoing contributions, but even including the new cash, the declines appear smaller than the losses reported from many large institutional managers.

Why did the individuals seem to do better?

  • Well, they tended to follow a simpler investment strategy that included balancing their holdings between stocks and bonds.
  • Compare that to many large pension and endowment managers who didn't use much balance, but instead relied on their superior stock and alternative investment picking abilities, which didn't turn out to be all that superior.
  • Individual investors apparently understood their limitations, whereas institutional managers didn't.
Turnover. Vanguard reports that most 401(k) participants made no trades at all, and only 16 percent of participants made any trades during 2008. That's amazing considering that last year produced record volume on the stock exchanges.
  • Yet many institutional managers had massive turnover last year. They appear to have panicked while the amateurs remained calm. Isn't it supposed to work the other way around?
Group Think. One of the dangers of concentrating investment authority with institutional managers is that they tend to think alike. They use the same strategies, same consultants and benchmark themselves against the same statistics. So, in this crisis, they generally made the same mistakes, which included being too aggressive and using too many complicated investments.
  • Whereas individuals tend to think for themselves because they're on their own. The result of millions of 401(k) investors making independent choices is that you don't concentrate the decision making with a small group of people. This actually tends to work better for investors and the markets as a whole.
Chasing Wall Street. Because most institutional managers must continuously attempt to beat the market to justify their services, they generally have a financial incentive to take more risk. That's alright if they do it with their money, but when they're given billions to manage in employee pension plans, it's your money and their decisions have a direct impact on your financial security.
  • While chasing Wall Street may lead to big bonuses and fees for institutional managers, it may not be in your long-term best interest. You're more likely to meet your goals over the long run if you focus on executing on the fundamentals, which include saving adequately, saving consistently and balancing your investment holdings.
Bottom line. The investment decisions made by individuals who are focused on their own unique needs and risk profiles may be just as good, and at times better than, those made by institutional managers.

As with all financial matters, consult your individual advisor prior to making any decisions.