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Dec. 15, 2004

Stock investors' returns are lower than they think

ANN ARBOR, Mich.—Stock market investors are getting poorer overall returns than they realize, says a University of Michigan business professor.

This is because stock returns historically have been measured on a buy-and-hold basis, which does not account for different returns that occur at different points in time.

A new study by Ilia Dichev, associate professor of accounting at Michigan's Stephen M. Ross School of Business, contends that traditional buy-and-hold returns fail to assess the return experiences of stock investors because they ignore the timing effects of capital flows in and out of securities.

Instead, Dichev suggests using a new, more accurate measure that involves the dollar-weighting of returns (i.e., the returns generated by bigger investment amounts receive greater weighting than the returns from smaller investment amounts) and, therefore, properly reflects the effect of investors' timing.

"The compounding of buy-and-hold returns reflects the investing experience of passive buy-and-hold investors and assumes an equal weighting of returns over time," Dichev said. "However, most investors are actively trading or otherwise engaging in stock-capital transactions.

"As a result, they are consciously or unconsciously timing particular stocks or the market as a whole, and varying their net investment exposure over time. Thus, while buy-and-hold returns provide a good benchmark to track the investment performance of stocks, they can be a poor measure of the actual return experience of investors, if capital-flow timing affects stock returns."

Dichev examined the long-run returns following all capital flows over the entire history of available stock returns and across the United States and many foreign countries. His findings indicate that aggregate dollar-weighted returns are systematically and considerably lower than buy-and-hold returns.

The return differential is 1.3 percent for the NYSE/AMEX market between 1926 and 2002, 5.3 percent for the more volatile Nasdaq between 1973 and 2002, and an average of 1.5 percent for 19 major stock markets around the world between 1973 and 2004.

"The results provide comprehensive evidence that stock investors' actual returns are considerably lower than those from passive holdings and very different from widely published and studied security returns," Dichev said.

Information on Dichev: http://www.bus.umich.edu/FacultyBios/FacultyBio.asp?id=000290980.

The study: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=544142

Contact: Bernie DeGroat
Phone: (734) 936-1015 or 647-1847
E-mail: bernied@umich.edu