Explain why investors often earn less than the funds they hold.
You can hold a fund for three years, read a healthy return on its factsheet, and then open your own account to find you have lost money in it. Both figures can be correct at once, because they answer different questions. The factsheet tracks one dollar that stayed in the fund for the whole period. Your account tracks your actual dollars, which entered and left on particular dates. People often call the distance between those two numbers the behaviour gap: the difference between a fund's published return and the return an investor actually earned in it. Few things show the cost of money behaviour as plainly.
The figure a fund publishes is a time-weighted return. Picture a single sum put in on the first day and left alone until the last, with nothing added and nothing withdrawn. The time-weighted return is how much that sum grew, and it describes the fund's performance.
Your result works differently, since it depends on the dates your money went in and came out. You can own the same fund and still do worse than it if the bulk of your money arrived shortly before a fall. Economists label this personal figure a money-weighted return (some say dollar-weighted return). It describes your performance.
Every holder experiences the same fund performance. Any gap between one investor's result and the fund's comes from the timing of that investor's money and from nothing else.
Suppose a fund goes up 20% in year one, down 20% in year two, and up 20% again in year three (made-up figures). A buyer who held from start to finish ends 15.2% up, since 1.2 x 0.8 x 1.2 = 1.152. A number like this is what appears on a factsheet under "over the past three years".
Hui Min (an invented example) puts S$5,000 into the fund at the start. A good first year lifts it to S$6,000, and the strong figure gives her confidence. She adds S$10,000, bringing her holding to S$16,000.
The fund then drops 20% in year two, taking her S$16,000 down to S$12,800. She can't bear watching any longer, so she sells the lot at S$12,800 and sits in cash for year three, during which the fund climbs 20%.
Her totals are S$15,000 paid in and S$12,800 taken out, a loss of S$2,200. The factsheet reports a healthy return over the past three years, and her account shows a loss in a fund that gained 15.2%.
Suppose instead she had still added the S$10,000 but kept holding. She would have finished with S$15,360 (S$12,800 x 1.2), a gain of only S$360 on S$15,000 and still well short of the fund's 15.2%. That shortfall is purely a matter of timing, as most of her money went in just before the fall. Selling after the fall was the costly step, because it converted a shortfall into an actual loss.
A gap is not always a mistake. Some of it can come simply from when money happened to arrive. If you put in a regular amount each month, your result will differ from the fund's for this same reason.
What Hui Min did is the pattern most associated with investors earning less than their funds. After gains, a fund looks safer and more appealing, so money tends to come in close to the high points. After losses it looks dangerous, so money tends to leave close to the low points. Module 6 goes into the patterns behind this, including recency and herding.
Morningstar, the fund research firm, runs a regular study setting the returns investors actually earned in funds against the returns of the funds themselves, worked out from the money flowing into and out of each fund. Its studies have generally found that investors earned less than the funds they held. The size of the gap depends on the year, the type of fund and the method used, and other researchers have raised questions about some of those methods, so be careful with any single figure you see quoted. What you can rely on is the direction: the fund itself is rarely the main reason an investor does badly.
Funds with bigger swings, such as single-sector or thematic funds, tend to show a wider gap, since large moves tempt people to buy and sell more often.
You narrow the gap by making fewer timing decisions and settling the remaining ones before you need them. Two habits cover most of it:
A monthly investment set to go in on the same date no matter what the news says, which removes the choice of when to buy. A written rule, made in advance, for what you will do when the market falls, which removes the choice of whether to sell.
To see what a fall does to a balance in dollars, read Investing 101, lesson 7.3, "What a market fall looks like in your own account". To draft your rules for a fall, use Build and run an ETF portfolio, lesson 8.2, "Rules for when markets fall and when they boom".
These habits guarantee nothing, and markets can fall for years. They only raise the odds that you collect most of whatever the fund earns.
Your own records are where this becomes real. Most brokers and platforms list your transaction history with dates and prices. Pick one fund or ETF you hold or used to hold, pull up those dates, and look at what the price had been doing in the weeks before each one.
Pick one fund or ETF you hold. Write down the dates you bought or sold, and whether each one came after a rise or a fall.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).