Every year, Morningstar releases a report called “Mind the Gap,” which looks at how people invest their money and how well their investments perform.
The report compares the difference in returns between investment funds and the returns earned by those investing in them. The latest report shows that investors received a 7.7% return over the ten years ending 31 December 2020. However, the funds they invested in produced a 9.4% annual total return over the same period.
A 1.7% difference in annual returns may seem small, but it could lead to a significant loss of returns over time. For instance, if you invest £250,000 over ten years, this difference could result in £100,000 of lost returns. This could impact your ability to achieve your desired lifestyle in retirement.
Why did the average investor underperform despite investing in these funds?
The report blames “mistimed purchases and sales” or what Carl Richards calls the “Behavior Gap.” Vanguard’s Fran Kinnery says it is “a lack of professional planning.”
Emotions, particularly fear and greed, often influence investment decisions. For instance, during the 2008-09 global market downturn, some investors panicked and withdrew from the market right before it rebounded. This resulted in them locking in their losses and then regretting their decision as they watched the markets climb. Conversely, some investors let greed take over and make impulsive decisions based on the fear of missing out on a great investment opportunity. As a result, investing based on fear or greed can lead to buying high and selling low, which is the opposite of what you want. To make sound investment decisions, it’s essential to remain rational and avoid being swayed by emotions.
How can I reduce my gap?
If you want to reduce your gap and achieve your investment goals, here are some tips to consider:
Have a plan when investing money
When it comes to investing money, having a plan is crucial. It will help you establish a clear set of goals and objectives from the beginning, which you can adjust and refine as you move forward with your investment journey. These goals and objectives will guide your investment decision-making process based on various factors. After creating an investment plan, it’s essential to follow it diligently. Many investors need to be more focused on short-term fluctuations in the value of their holdings, which makes them over-manage their portfolio by frequently switching investments and trying to recover their losses. Instead, exercising patience and remaining committed to the original plan is better.
Ignore investment tipsters
Investment managers can access teams of researchers who meticulously analyse business data to make informed investment decisions. However, despite this advantage, almost 90% of actively managed funds failed to outperform the market over a 15-year period up to 2020. If most fund managers, with their vast resources, fail to beat the market, it is unlikely that the average investment pundit will perform any better. While they may occasionally get lucky and succeed, it is doubtful that their less successful investment tips will be widely publicised.
Do not try to time the market.
Investing is a complex process that requires patience and a long-term approach. One of the most important rules of investing, if not the most important, is that time in the market is more valuable than timing the market. This means that if you invest and hold your investments for a long time, you are more likely to see a higher return on investment rather than frequently switching your holdings to try and outperform the market. Therefore, it is wise to have a long-term investment strategy based on solid research and analysis and avoid making impulsive decisions based on short-term market volatility.
Don’t only focus on the UK.
Many investors tend to invest most of their money in their home country, called home bias. By doing so, investors miss out on the opportunity to invest in faster-growing economies and face higher risks. Diversifying your portfolio and considering investing in markets outside the UK to reduce your risk exposure is essential.
Diversify your portfolio
According to Morningstar’s report, investors who chose to invest in funds that combined multiple investment classes, such as stocks and bonds, only experienced a 0.69% loss over the past decade. This highlights the importance of diversification in investment. You can reduce your risk exposure by spreading your investments across different markets and asset classes.
Get financial advice
According to Vanguard Asset Management, financial advice can provide an average annual value of 3%. They believe that helping clients maintain a disciplined approach to investing is vital for long-term success.
By following these tips and maintaining a disciplined approach to investing, you can reduce the gap between your investment returns and the returns of the funds you invest in and achieve your investment goals over the long term. If you’d like to see how we can help, you can book a free, no-obligation chat here.