Chart of the Week: You are your own worst enemy
Results from the latest Mind the Gap study.
This week’s Chart of the Week comes from Morningstar’s latest Mind the Gap study. We quote this study extensively as it illustrates the power of your behaviour on your total returns.
Although the study is conducted with US market data, the insights are relevant to Australian investors due to the similarities of the markets.
The latest edition of the Mind the Gap study estimates that the average dollar invested in managed funds and Exchange Traded Funds (ETFs) earned 7% per year over the 10 years ended December 31, 2024 (‘investor return’). That’s about 1.2% per year less than the funds’ 8.2% aggregate annual total return (’total return’) over the span assuming an initial lump-sum purchase.
That 1.2% ‘investor return gap’, which is explained by the timing and magnitude of investors’ purchases and sales of fund shares during the 10 year period, is equivalent to around 15% of the funds’ aggregate return.
Behavioural risks reflect our tendency as humans to act emotionally during volatility. We are driven by fear and greed, which is a formula for buying at the top of the market and selling at the bottom. Both individual and professional investors create elaborate models and theories designed to dictate when and why to buy or sell a security. Despite these models there is still a high probability that investors will panic when the market is going down and fear missing out on profits when it keeps climbing.
These actions have been shown to be to the detriment of the returns an investor achieves. This is the ‘behaviour gap’ that’s displayed in the study - the gap between an investment return and the return an investor gets in the same time period. Constantly switching between investments and assets due to emotional responses has been proven to reduce returns for the majority of investors.
This gap between the returns investors actually experience and reported total returns can be attributed to a few reasons—cash flow timing, costs and tax efficiency.
I’ve run a model that looks at the real cost of poor behaviour. Although it is based on a previous edition of the study, it demonstrates that you are your own worst enemy, and one of the biggest detractors of your portfolio returns.
You’re able to find previous editions of Chart of the Week here.
