Stock Market Participants' Returns are Lower than Index Returns

Just read a very interesting paper in the American Economic Review (here is an earlier version). The author demonstrates that the average stock market participant - we're not talking just individual investors here but all participants - earns less than the index return. This is because companies tend to issue more stock when stock prices are high and make more distributions - dividends and buybacks - when prices are low. For 1926-2002 on the NYSE/AMEX exchanges the buy and hold index return was 9.9% and the dollar weighted actual return experienced was 8.6%. On NASDAQ the respective numbers for 1973-2002 were 9.6% and 4.3%! That's the effect of all those dot.com stocks issued at the height of the 1990s boom. Similar results are found for other countries. In some the effect is larger and some smaller (e.g. Australia). This drag on performance isn't quite the same as that of brokerage and management fees (though those can be reduced too) because at least in theory :) you can avoid buying overpriced IPOs. Though if a stock you own is issuing more shares causing dilution I guess that is part of this effect too. And this is also before the fact that small investors tend to be less knowledgable (but maybe overconfident) and underperform large investors.