Underperforming Yourself

Investors may understandably be puzzled if their investment returns are very different from the managed investment funds holding their money. Vanguard analysts in Australia and the US have examined this phenomenon in which investors appear to be effectively underperforming themselves.

The analysts have carried out long-term comparisons of the returns that investors personally receive and the returns of the funds.

Their research shows that many investors commonly receive much lower returns than the funds holding their capital.

The performance gap suggests "return-chasing behaviour" by investors. This involves switching to funds to that have produced high recent returns and later sacking those funds once their performance lags.

The research confirms that cash flows into funds "tend to be attracted by, rather than precede, high returns". And often the mostly-recently hired funds subsequently underperformed the fired funds

Vanguard’s classic US research paper Adviser’s alpha, which was updated and republished in 2013, and its Australian edition, published this year, includes an examination of the phenomenon of investors underperforming their chosen funds.

Both reports emphasise the critical role that financial advisers can perform in encouraging their clients to adopt a disciplined, long-term approach to investing. This is the opposite of getting caught up with the prevailing emotions of other investors and chasing the latest winners.

"Adviser’s alpha" is defined as the value that advisers can add through their wealth management and financial planning skills that are unrelated to trying to achieve market-beating performance.

This involves advisers guiding their clients in such areas as appropriate asset allocation, cost and tax efficiency, and portfolio rebalancing – and acting as behavioural coaches.

Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia. As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment.