Chasing performance is not always a smart move

 Hand pointing to a graph-134Have you ever wondered why your investment does not seem to reflect the same earning rate as what is published in the paper, online or in some glossy document?
Morningstar has recently released analysis indicating New Zealand investors generally fall below published fund performance figures. Tim Murphy –Morningstar head of manager research suggests the ‘fear and greed’ behavioural cycle is the cause of this underperformance. The Morningstar NZ research - which matches findings in other jurisdictions – found the ‘behavioural gap’ where people tend to buy and sell on recent fund performance results, can materially affect actual investor returns.

 

Beat the behavioural gap

Milestone has 5 tips for avoiding this behavioural gap and ensuring that your investments have a better likelihood of achieving the published fund performance figures.

 


1.    Think long term: Decide when you actually want to use some or all of this money. If it is not until years into the future, then avoid the short-term market noise and hype. Is the actual investment or the asset class likely to rise over the long term? If no, then avoid it. If yes, then invest in and stick with it for the duration or until the fundamentals around that investment or asset class change.

2.    Be realistic on your expectations: The period from 2009 – 2015 was exceptionally good for shares and fixed interest funds. This saw year on year growth well above long term averages. Eventually shares reach full value plus interest rates bottom and from that point, total returns (income and capital gain) fall and for periods can be negative. Work with your financial adviser to identify what sort of return you need to achieve your financial goals and avoid the temptation to chase the highest performing investment or managed fund. In this part of the market cycle, getting a higher return will often involve taking more risk. We recommend you revert to thinking about the 30 year average return on asset classes rather than the average return over the past five years.

3.    Avoid the lemming effect: Lemmings are often remembered as those little rodents who blindly follow one another and jump off cliffs to their death. Unfortunately, humans also like to follow the herd and do what others are currently doing. If the markets go up, then the media publicise this and more and more investors buy what has increased in price believing that it will keep rising forever. Conversely, when markets fall, the media publicise the perils of being invested into this or that and consequently, a number of investors sell at heavily discounted rates- and by doing so, they may wipe out much of the gain from when they purchased the investment. Disciplined active fund managers will look at falls in market prices as an opportunity to buy quality assets and when prices rise to what they regard as being overpriced, then they sell some or all of that overpriced asset. This is counter to what the average mum and dad investor working by themselves tend to do.

4.    Check timeframes: When comparing your investment return to the published investment return, check that you are comparing the right time period. Your report may be for a period 1 April to 31 March yet the performance you are looking at online may be for a different 12 month period. In today’s volatile market just one month can make a significant difference to the 12 month performance.

5.    Dollar cost averaging alters the investment return: The published investment performance is based upon 100% of the investment being made on day one of the investment period and being in the fund until the last day of that published period. However, dollar cost averaging is where you are adding money to that investment on a regular basis (often monthly). This means that at the end of the reporting period, the total amount in the fund is not what has been there for the entire reporting period. Over time, dollar cost averaging tends to reduce your investment risk and improve your returns but it does take a number of years before this is obvious.

Talk to a Milestone financial adviser if you have any questions around when to invest, what might be an appropriate investment for you, and why your investments are not showing the same total return as what you have seen published elsewhere.