Staying invested is the surest way for investors to avoid timing-related costs, and they should not sell because of political or economical uncertainty, says Paul Nixon, the head of technical marketing and behavioural finance at Momentum Investments.
Nixon was commenting on Morningstar’s recently released 2019 Mind the Gap study, which uses investor returns data to measure the cost of bad timing.
He said the findings of this year’s study (which looked at 10-year returns for the years ended 2014, 2015, 2016, 2017 and 2018) support an outcomes-based investment philosophy, which shifts the focus from chasing arbitrary market benchmarks towards investing in order to meet defined goals.
Nixon said that investors would have suffered far less at the hands of bad timing if they had opted for an outcomes-based approach.
“The 2019 Mind the Gap study reveals that the average investor lost 45 basis points to timing over five 10-year periods ended December 2018. While this may not seem that extreme, it is important to remember that this is an average, so there are some investors who likely lost as much as 10 times this as a result of one poor investment switch,” said Nixon.
The gap between potential and actual returns is essentially a form of investors self-sabotaging their future financial success, and staying invested remains the surest way to avoid these timing-related costs.
“The study reveals that this is especially true during uncertain economic times, with the ‘gap’ widening around dramatic market reversals. This is because investors tend to panic, which results in selling when the market drops and missing out on the subsequent recovery.
“To minimise the costs of bad timing, an outcome-based investment approach is therefore suggested. The objective of an outcome-based solution is simple: to keep clients invested. This approach is about building predictability into returns by retaining focus on the end goal and not trying to outperform the market over the short term,” said Nixon.
The study found that a wider gap resulted when investors invested in funds with a higher volatility.
“If markets are going to be a little more choppy, it will feel that you will need to switch or get out of that and into something else, and that’s what creates a gap.
“The second thing I found interesting was the fees angle. They (Morningstar researchers) also found that investors in more expensive funds tended to jump ship as well,” said Nixon.
He said investors are more aware of the impact of fees than they were 20 years ago, when markets were returning about 20% plus and investors did not really care whether they were paying 1% or even 2% in fees.
“In the current climate, where returns were difficult to come by, investors are really scrutinising how much they were paying and how much they’ve got. So Morningstar found that where funders charged a lot, investors tended not to stick with them, and when they don’t stick with something, it means that they are switching and means they are opening up a gap,” he said.
Nixon said investors in asset allocation funds experienced a positive gap.
“Investors had the best experience in the asset allocation fund, and that kind of goes into the outcomes-based approach and asset allocation funding is just going to spread your risk or diversify your risk among a number of asset classes or geographies.
“Diversification is really a good experience as it tends to give investors a chance of sticking with what they’ve got, and Morningstar has also found that, and we found that an outcomes-based approach gives investors a better experience, and they actually have the lowest gap in outcomes-based funds. It goes to the fact that there is less volatility.
“Asset allocation provides an easier or smoother ride, and investors actually tend to stick with the plan and go with that kind of approach.”