Dalbar's Harvey agrees. "In contrast with the premise that ETFs encourage stable investors to trade, I interpret the results as ETFs attracting investors who are intent on trading," he says. "The ETF temptation effect is an attractant, not a behavior changer."
In short, ETFs don't kill returns; investors do.
Vanguard, of course, is only one corner of the funds universe, as are ETFs. Since 2006, data provider Morningstar has tracked "investor returns," which are not to be confused with fund returns. If a fund returns 10 percent for some time period, its average investor almost invariably earns less than 10 percent, because he or she tends to get in and out of the fund at the wrong times.
In the five years through May 31, Morningstar's Terry Tian recently wrote, the gap between investor returns and total returns was 1.27 percent for the large-cap blend category, and 1.26 percent in short-term bond category. Over 10 years, the numbers fall to 0.39 percent and 1.02 percent, respectively, Tian wrote. It's worse with alternative funds—essentially those outside the stock-and-bond world. There, investor returns over the five-year period lagged total returns by an annualized 2.25 percent: the funds produced 0.21 percent, while the investor lost 2.04 percent.
And, just in case you're not thoroughly demoralized, let's not forget Dalbar's latest QAIB, which reads like a Harper's Index of investor haplessness. Among its more memorable items:
- The average equity investor underperformed the S&P 500 by an annualized 4.32 percent over the past 20 years.
- In 2011, the average equity-fund investor lost 5.73 percent, compared with the 2.12 percent simply holding the S&P 500 would have generated.
- The average fixed-income investor underperformed the Barclay's Aggregate Bond Index by an annualized 5.56 percent over past 20 years.
- Both equity and fixed-income mutual-fund investors have underperformed the market on a one-, three-, five-, 10- and 20-year annualized basis.
- The average investor in asset-allocation mutual funds (balanced funds, target-date funds and the like) outperformed the average equity investor last year for only the sixth time in the past 20 years.
- The average fixed-income mutual-fund investor has not kept up with inflation on a one-, five-, 10- or 20-year annualized basis.
At the root of all this pain are a handful of behavioral biases that this column will explore in greater detail down the road. For now, let's be thankful there is a hint of pleasant news from the good folks at Dalbar: The gap in the long-term annualized return of the average mutual-fund equity investor and the S&P 500 narrowed in 2011 (that 4.32 percent cited above), as it has more or less consistently since 2000, when it was 10.97 percent.
The reason, thinks Dalbar, is that investors who entered the markets in the 1990s "have now experienced multiple market declines and recoveries and have learned from those experiences. They found that remaining invested has, over the long term, produced positive results."