An individual investor might be worried about the funds he picks or about his assets manager, but according to the theory called “behaviour gap”, the investor should first be worried about…himself. This tendency for investors to underperform the funds they are invested in is called the “behaviour gap”.
The following hypothesis illustrates this theory:
• An investor has €100,000 to invest, but does not know when and where he should invest
• He chooses to invest half of his capital and during the first 6 months, the fund increases by 20% so he decides to invest the remaining €50,000
• However, during the following 6 months, the markets fall by 10%. During this year, the fund has increased by 8% but his investment has fallen in value by 1%.
• The first investment of €50,000 has gained 8% so is now worth €54.000 but the second investment suffered the 10% fall and is now worth €45.000
• At the end, the €100,000 investment is worth €99,000 even though the fund he picked increased by 8% over the year.
According to this theory, investors have a tendency of buying high and selling low. Investors don’t buy at the top and sell at the bottom and the studies underline that it is their market-timing efforts which cost them.
In terms of figures, whereas the average fund returned 10% annually between 1980 and 2005, the average fund investors returned 7.3% according to Vanguard group. The gap between the two returns is the behavior gap.
The studies recognize that it depends of the investors: some will do better than others, but it appears that even investors who are able to select the best funds may suffer from those choices since buying cheap stocks can beat the market.
Research Affiliates concludes: “investors are so spectacularly bad at market timing that they routinely wipe out all, or more than all, of the outperformance produced by value-oriented managers”.
As part of the Capital Market Union, BETTER FINANCE has raised the need to restore the trust and confidence in capital markets Investors need transparent and comparable information regarding past and future performance.
Read The Irish Times article here
Read the article “Behavior Gap: The Psychology of Investing” here