A number of studies over the past five years have suggested that most investors are better off and earn higher returns when they work with an advisor rather than go it alone.
John Bogle, founder of Vanguard Funds, which is the largest family of index funds in the U.S., studied 600 general equity funds for the 20-year period of 1983 to 2003. He found that the average investor’s return in those funds was roughly 2.4% per year less than the average return for the fund itself over the same period. How does this discrepancy arise? Mainly, from investors behaving badly. They had more invested when the funds did poorly and less invested when the funds did well.
Typically, funds don’t gain popularity until they have posted good returns for several years. At this point the media and investors sit up and take notice and pour substantial dollars into the funds, based on their excellent recent performance. The problem is that many investors weren’t around to enjoy those great returns. And when the investment cycle turns and performance drops off, many investors panic and sell at exactly the wrong time. Thus, investors’ returns on average are much worse (due to their own poor timing) than the actual returns for the fund.
Closer to home, a study by mutual fund analysts Duff Young and Aaron Brown looked at Canada’s 100 largest funds with a 10-year track record for the period ending September 30, 2002. The results were even more alarming. Young and Brown found that the average investor underperformed the fund returns by more than 4% annually. This is a shocking gap. In their words, “The prob-lem, as this study points out, is that while funds do fine, people don’t.”
The question, then, is how can you insulate yourself from this typical but self-destructive behaviour?
First, by being aware of the phenomenon, you can fight the natural tendencies of greed and fear.
Second, make sure you have a strong enough relationship with your advisor so you can discuss the ups and downs of investing and accept his/her reassurance that all investment cycles are temporary. Sometimes the best strategy is to do nothing, but be patient and disciplined.
Third, make sure your asset allocation is appropriate for your risk tolerance. If you have enough low-risk investments, it will cush-ion the blow so that when the inevitable market declines happen, you don’t panic.
As your investment advisors, we make our best efforts to choose the “right” funds for you. But our job is much more than that. It’s about education, encouraging good investment habits, matching your return requirements to your goals and risk tolerance. And perhaps most importantly, it’s about having a relationship, so you can talk to someone when things don’t go well.
Over the long term, good investment habits likely have a much greater effect on wealth creation than picking the “right” investments at the “right” time, which is very difficult, if not impossible, to do consistently. How you invest is perhaps more important than what you invest in.
Planning, discipline and patience. The same old mantra never goes out of style.
www.fraserfinancial.com
