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Great Fund Bad Investor

Posted by Myles B. Brandt, CFP® on 5 February 2013 | 0 Comments

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One of our core beliefs is that market timing is mostly counterproductive. Although some market timing is based on strategy, fear and greed rule the hearts and minds of most investors. Because of this, investors, even professional ones, can under-perform the actual funds they are invested in.* This is called the Behavior Gap.

Morningstar has a great article highlighting this for different types of funds over the past 10 years. The one that sticks out the most is the category of international stocks. The average fund returned 9.95% over the past 10 years while the investor got 6.84%, or 3.11% less per year. The implications of this are huge over long periods of time. Consider that $10,000 invested at 9.95% grows to $25,819.77. The investor would have grown his $10,000 into $19,378.33, or 25% less.

There are ways to close the behavior gap.

1. Always stay invested. Choosing an appropriate risk level to begin with will be of the utmost importance.

2. Rebalance to your risk level as the investments move around.

3. Use funds that do not have a lot of "hot money" coming in and out of the fund. Index funds are particularly useful for this as the majority of investors in the funds are long-term and disciplined.

 

*Fund returns are calculated using time weighted returns which assumes $1 invested at the beginning of the period and no additions or subtractions. Investor returns are internal rate of returns which take into account flows.


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