Mind the gap
UK INVESTORS’ UNDER-PERFORMANCE MIRRORS US STUDIES
Since 2005, the research services group Morningstar has been running annual studies in the US to measure the returns investors receive, on average and on a money-weighted basis, from the funds in which they invest compared with the actual returns which those funds achieved on a time-weighted basis. Now, for the first time, it has carried out a similar study in the UK and released its report earlier this month.
The US study has become known as the ‘Mind the Gap’ study due to the results illustrating that, on average, investors tend to enjoy a rate of return which is somewhat lower than the actual returns of the funds in which they invest.
This inaugural UK study has determined that whilst a gap exists, as it does in the US, the performance gap is currently quite small — the largest gap being just over 0.5%pa — although compound that over a long time period and it’s still a significant reduction in pounds in the investors’ pockets.
Morningstar’s US studies benefit from having many years of data, whereas this first UK study looks at only five years of data (this is simply due to longer-term data not being available in the UK), so whilst on the one hand we’re only looking at a short data set, it needs to be borne in mind that the data set covers a time period during which markets have pretty much moved in just one direction — up.
Based on the US data, I believe it is reasonable to assume that the data would look much worse if it included, for example, the 2008–09 financial meltdown.
The reasons for this underperformance by investors have often been debated and one of the main factors may simply be poor market timing on the part of the investors — timing which is almost certainly driven in large part by their emotions.
The ‘buy low, sell high’ philosophy, which can best be implemented when emotion is removed from the equation, would appear to be much harder to achieve when investors are faced with the reality of market noise, hence their investing experience is more likely to look something like this:
The more investors allow their emotions to drive their investment decisions, the more likely they are to have a less than optimum investment experience.
Luckily, there’s a simple answer (you knew I was going to say that, didn’t you?).
· Step one: download our Guide to Investing. It’s full of useful information to help you to avoid making the mistakes so many investors make.
· Step two: create a robust rebalancing process that you can easily implement when markets are volatile and make a commitment to yourself NOW, that you WILL use that process to rebalance your portfolio (your process should include exactly what will trigger a rebalance — for example your asset allocation moves more than 10% outside the limits you have set. You do have a set asset allocation for your portfolio, right? If not, you can learn about that in the guide too).
· Step three: when a requirement to rebalance is triggered, REBALANCE. Ignore what’s going on in the market. It’s all about FOCUS.
As Warren Buffet once said, ‘Investing is simple, but not easy’. The above process is simple, but not everyone will be able to implement it. Controlling our emotions is not easy, in any aspect of life. Some are better at it than others. If you think you might be someone who would find it hard to implement this process then talk to a professional. The fees you pay to have someone help you to stay the course will be worth every penny, and more, when markets next conspire to test your emotions. Be in no doubt that they will, quite possibly at a time when you don’t expect it and when it is hardest to resist.