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Mutual funds and
ETF’s
Where
the trading impact on gross returns is easiest to observe and measure is in
mutual funds and exchange traded funds. A performance gap is observed between
the returns of funds themselves and the returns of the investors in the funds. The
gap is caused by investors selling in and out of funds, presumably based on
their perceptions of where markets are headed. Because market timing is rarely
regularly successful in the long term, the performance gap is a negative one:
·
John Bogle,former chairman of Vanguard, has estimated it for ETF trading at
200 basis points (2.00%) of lost returns each year and even higher for moving
into and out of mutual funds; see Bogle 2011
doc.2231; and Canadian Capitalist
2011
Bogle Estimate PDF doc.2214.
·
According to a 2010 Cass business school study sponsored by Barclay’s
Wealth the average annual return from UK equity
funds was 6.5 per cent, but the average private investor made only 5.3 per
cent, leading Barclays in 2011 to
estimate that what it called emotional
trading by wealthy investors had caused a 20% loss of returns over 10 years; see Clare Cass
doc.2216 UK
mutual fund trading; Barclays 2012 wealth trading study
PDF doc.2210B; Sommer
NYT 2011 Barclays Wealth 2011study of trading announcement PDF doc.2224; Vincent
FT doc.2226; and Shah 2010 doc.2223.
·
Maymin and Fischer find that the average US mutual
fund investor lags the average performance of his fund itself by an average of
1.95 percent per year over the past fifteen years, based on net investor cash
flows of 25,000 mutual funds; see Maymin and Fischer doc.2219.
If you don’t think the performance gap issue is significant, consider this: a
gap of 1.95% left US mutual fund investors with next to no return after taxes and inflation over the last 15
years. Here is a pie chart from Maymin and Fischer’s paper
showing this:
For
more on this investor- fund performance gap, see Sullivan PDF doc.2228; and Individual
stock picking by the individual investor: the pitfalls
.
Other undesirable
side-effects of trading
So,
excess trading can result in significant additional turnover costs and tax
costs, and hurt gross portfolio returns. But this is not the end of the story.
Excessive
trading has additional results:
-
Simplicity is the friend of investors; for more, see How to invest simply- a 10
point checklist . Excessive trading complicates investing,
making it more difficult to keep an overall view of one’s portfolio, often resulting
in poor diversification. Simplicity is in fact the
opposite of investing in shares of individual companies. You would need to
invest in hundreds of different companies to ensure that your portfolio
approaches being as diversified as an investment in a single index fund.
- It complicates tax and accounting.·
- It is time-consuming. Each time you trade, someone
as smart as you has taken a reverse position i.e. he thinks you are wrong. You
have just created a full time job for yourself. Is that really what you wanted?
- It can lead to panic
trading. Excessive trading often leads to your investments being too complex.
You will have trouble understanding and managing the risks you are taking and
you will likely wobble when markets get tough.·
Do-it-yourself
investing is not for everyone, but it can offer many advantages in terms of reduced
costs and greater control over one’s financial affairs. Many investors retain
an adviser because they find investing too complex and time consuming. Regrettably
they often adopt trading patterns that worsen these challenges, and prevent them
from being able to even consider do-it-yourself investing.
If your portfolio is not simple you may end
up relying upon and paying others, even when that may not be your objective.
Paying on a one-off basis for advice to develop your investment policy is money
well spent. Paying others on an ongoing basis, simply because you have over
time made a set of investments that have become so complicated you can’t manage
them, is not. How to invest simply- a 10 point
checklist .
Conclusion
In the
next commentary we look further at the trading paradox of why investors adopt a
behavior that is contrary to their own interests, before outlining
recommendations that may increase the likelihood of investors following better
investing practices.
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