Blog - Investing Notes

February 4, 2005 – Returns for Investors (Rather Than Markets)

In his June 2004 paper on "What Are Stock Investors’ Actual Historical Returns", Ilia Dichev examines stock market capital inflows and outflows to determine how well investors really perform compared to buy-and-hold returns. He concludes that:

• There are transactions that affect the total amount of capital invested in the market, such as dividend payments, initial and secondary stock offerings, stock repurchases and exercise of stock options. There are material correlations between these non-washing capital flows and subsequent returns that affect the actual experience of investors.
• Dollar-weighting of returns captures the aggregate timing effects of all capital flows between investors and the stock market.
• Dollar-weighted compound returns are 1.3% less than buy-and-hold returns for the NYSE/AMEX during 1926-2002. Dollar-weighted returns are 5.3% less for the NASDAQ during 1973-2002, and 1.5% less for major international stock markets during 1973-2004.
• Many investors trade rather than buy and hold. Equity risk premium calculations based on buy-and-hold returns are therefore upwardly biased.
• Stock returns do tend to be lower after capital inflows and higher after capital outflows.

In summary, the actual aggregate (timing) experience of equity investors is inferior to passive buy-and-hold stock market returns. An active approach of buying after pronounced capital outflows from the market and selling after pronounced capital inflows to the market is likely to be successful.

See our blog entries of 2/1/05 (Chapters 4, 12 and 13) and 12/16/04 for the Triumph of the Optimists conclusions on equity returns and the past/prospective equity risk premium. See our blog entry of 11/10/04 for another approach to putting real-world constraints on theoretical buy-and-hold returns. See our blog entry of 10/29/04 for additional evidence that, in aggregate, trading underperforms buy-and-hold.