Mind the (Behaviour) Behaviour Gap

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29 Apr Mind the (Behaviour) Behaviour Gap

It’s highly unlikely you will read this in the money section of your Saturday newspaper, but an average investor losses an estimated 2.49%pa in investment returns to ‘behaviour gap.’  Behaviour gap (or performance gap) is the difference between return on an average fund and the actual return investors in that fund enjoy.

It may surprise you, but the fact is that average investor get much less than the return of the funds they invest in because they tend to buy into a fund after it’s performed well and sell out after it’s tanked. In essence, typical investors buy high and sell low, which is the exact opposite of what sound investment practices should be.

mind the gapLatest data from Morningstar [1] (US) shows this gap between the average investor return and the average fund return has ballooned to a mind-blowing 2.49% by the end of 2013, up from 0.95% 10 years ago.  While this research is based on US investors, there is every indication that the picture for UK investors would be very similar. A 2010 working paper [2] by the Cass Business School shows that the behaviour gap costs an average UK investor around 1.2% per year over the 9-year period ending 2009. Compounded over a period of 10 or 20 years, this is a major dent to any investors’ portfolio.

So what does this mean? Well, one thing to bear in mind that chasing performance by moving in and out funds is unlikely to yield any productive result. Turn to the money pages of your newspaper, and you are bombarded with recommendations of top funds and top sectors to invest. But in the end, this amounts to little more than meaningless noise. Moving in and out of the market, from one top fund to the other or from one top sector to the other is going to do your portfolio more harm than good. In the long term, buy and hold still pays off, so best to ignore the noise. As a financial planner, a key part of my job is helping our clients avoid the tendency to chase investment performance; being a voice of reasoning to talk them out of being their own portfolio’s worse enemy, especially when markets are doing very well or very badly. I believe all good advisers discourage their clients from buying into a fund just because it’s performed well, only to sell when it’s tanked. Instead they help clients stay focused on what’s important – their goals.

[1] Mind the Gap 2014 by Russel Kinnel, Morningstar. http://news.morningstar.com/articlenet/article.aspx?id=637022
[2] Clare & Motson (2010) Do UK retail investors buy at the top and sell at the bottom? (working paper) Centre for Asset Management Research , Cass Business School