I have a bit of a commute and end up spending a lot of time in the car. Despite all this “practice”, I’m still terrible at predicting which lane of traffic is moving best when the all too frequent Portland traffic jam occurs. The left lane is moving, so I cut over only to see the lane I was just in surge ahead. Back to the middle and now the left lane zips past. While frustrating, the only thing this “lane-hopping” ends of costing me is a bit time. However, investors “lane-hopping” with their investments, end of costing themselves real money.
This week Morningstar published its annual “Mind the Gap” study. The analysis looks at the returns investors receive (dollar-weighted) compared to the funds they own (time-weighted). The difference, or “gap”, is a result of the timing of cash flow into, and out of the funds. The findings for 2016 don’t depart from prior years with the “Behavior Gap” (investor returns trailing the funds they own) totaling 0.53% across all funds. Russ Kinnel, the Director of Manager Research from Morningstar, sums it up as follows:
Generally, investor returns fall short of a fund’s stated time-weighted returns because, in the aggregate, people tend to buy after a fund has gained value and sell after it has lost value. Thus, they miss out on a key part of the return stream.
Next week Cordant is hosting an investing workshop for Intel employees (or anyone with assets in the Intel Retirement plan) titled “Navigating the Investment Options of the Intel Retirement Plan.” We will present a simple, 4-step process to manage your retirement accounts and give you the opportunity to perform a real-time self-assessment of your current investments.
One of these steps is a focus on performance, which I want to touch on briefly here. There are two ways investors hurt themselves when it comes to performance. The first is by selecting underperforming, high-cost funds. The second, as we saw with Morningstar’s “Mind the Gap” study, is to underperform the funds themselves.
This is a very real cost that investors end up paying. Again, for the ten years ending in 2016 Morningstar calculated this cost to be 0.53% across all funds, 0.74% for U.S. funds and -1.24% for International equity funds.
Because investing is cyclical, many times people pile into a fund or asset class after it just did well only to sell out when the fund lags. The chart below on the left is a stylized depiction of this behavior, and the chart on the right is actual data. What you see is that when the equity markets are doing well like the 2004-2007 period, people were moving money into stocks. Then in 2008 this behavior reversed.
People do this in real life. They buy high and sell low. And this hurts your investment returns.
There have been numerous studies done on this behavior. Each of the bars in the chart below represents a separate study on the “Behavior Gap” which again is the impact of these poorly timed buy and sell decisions that investors in aggregate make.
The lowest estimate from these studies is 1.2%, and the highest is a whopping 4.3%.
Unfortunately, on average investors tend to shoot themselves in the foot. When we talk about the importance of sticking with your investment strategy, this is why.
When stuck in traffic it’s tempting to get impatient and start switching lanes but this doesn’t often work. The lane that’s moving now isn’t the lane that’s moving next. The same thing goes for your investments. Don’t cost yourself money by allocating to the hot fund and selling your funds that have lost value. This is the opposite of the buy low, sell high behavior that is the first rule of investing.
In short, don’t “lane-hop” with your investments.
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