Do you rely on the returns which the mutual fund shows to you, or do you calculate the returns yourself? If not, then try doing it once. However, wait a minute. Don’t take the invested value shown in your mutual fund app. Instead, you should calculate returns on your own using the invested value, current fund value and time invested.
Investment returns that you see in the media or marketing material are based on the assumption that you invest a lump sum at the beginning of the period, and then you leave it alone. You do not buy or sell. You do not change your mind and trade with another fund. You just buy once and hold.
Investor returns measure your real-life return. The return you earn as you buy and sell your investments, or switch from one investment to another in your search for the next hot thing.
The gap could be caused by various reasons, or a confluence of them. This article focuses on reasons why investor returns are different from investment returns. Generally, investor returns are lower than the investment returns. Here is the list of reasons an investor should avoid:
- Timing the market: A lot of investors focus on timing the market to get the most out of the returns. Eventually, they don’t invest immediately and hence lose out on the incremental gains. The study says that in the absence of timing the market, investors generally make less return than those who don’t attempt to do so.
- Buying based on recent performance: No mutual fund has performed best every year. There is always a change in the rankings of the mutual funds. However, while investing, investors generally look at the recent performance. Investors should note that past performance is not an indicator of future performance.
- Lack of patience: Generally, investors invest their hard-earned money and are quite emotional about the fund value. In case the market is down, they panic and withdraw their investments. While technically this decision makes sense, practically it is driven out of sentiment and not based on any empirical study or analysis
- Chasing after a fad: Generally, people go after the current news and look for quick returns. In this chase of a fad, they generally rely on news rather than doing an insightful individual research. The result is that they are always late in identifying such investments when the prices are already high. One such example is the 3-year returns of pharma stocks post-COVID. The average investment returns stood at 23%, whereas the average retail investor returns were only 6%.
In order to avoid the above reasons, investors should maintain some discipline in their investments. They should practice following principles to avoid emotional decisions
Principle 1: Time in the market is more important than timing the market: Investors should focus on emotionless, logical decisions on investment discipline. Peter Lynch, one of the most successful mutual fund managers in the US, carried out an experiment of timing the market vs disciplined systematic investment planning over 30 years of data and found that the difference in the annualised returns between the two is less than 1%. This concludes that timing the market doesn’t achieve a significant benefit in the long term.
Principle 2: Carry out investment decisions involving the brain but without your heart: People are very emotional during their investment decisions. This is the main reason for lower returns. History has witnessed that intelligence goes down when emotions are high. An emotionless, pragmatic approach has achieved better results. In order to make right decisions, have a habit of empirical performance of mutual funds without having any bias. Your decision should be as if a computer system is making a decision based on a program. Make enough efforts on reasoning, defining the rules of investments. Once your system is ready, pick up the mutual funds based on the system. Provide at least 3 years before you change your decision and switch any mutual fund.
Principle 3: Patience is bitter, but the fruit is sweet. In the current world, everyone needs fast results. However, successful investment requires patience. Don’t stop your investments at the cost of fulfilling your wants (such as going for trips, buying a car, etc.), which can wait. The power of compounding provides astonishing returns if you wait for 25 years or more. To get these returns, you have to be consistently investing for 25 years. It’s never too late. Start today, regardless of your age. Patience is not the absence of urgency; it is the art of trusting the process—the wisdom to wait, while the seeds of effort take root.
Principle 4: Winners never quit. Quitters never win: Investors should not get down by recent temporary setbacks. The higher the research during the selection of the funds, the higher your confidence in staying put. For eg, Amazon, now one of the most valuable companies, has faced tough times — in the last 25 years, its share price has twice lost 90% of its value. Only select investors who showed perseverance during tough times got enormous results.
If investors follow the above principles, it will help them reduce the gap between investment returns and investor returns.
Amol Sugandh, MBA Finance, CFA, Financial Coach