Over the last 15 years the market* has returned on average 5.1% a year, but annualised investor returns are lagging behind at just 3%. It may not sound like much, but over this period the average investor could have missed out on a staggering 35% increase in their portfolio value. For those with £10,000 invested, this could add up to around £6,000 in lost gains.
So where’s the missing money?
In an insightful new study: Mind the Gap, why are UK investors missing out on returns?, Cambridge PHD student Charikleia Kaffe has investigated why investors are missing out and what they can do to maximise their returns.
The report should act as a wake up call to anyone with an interest in investing, and proves once and for all that it’s not about market timing, but time in the market that matters.
Laying the foundations
The report uses a simple statistical calculation called the time weighted rate of return (TWR) to calculate the underlying gains made by investors over 15 years. This return can be thought of as the actual results by DIY investors. The comprehensive analysis undertaken shows that the average return is a reasonable 3% a year.
As a comparative figure, the report created a model portfolio based around the average investor’s asset allocation of stocks and bonds. Underpinning this is the FTSE All Share Total Return for equity investments, and the Barclays Aggregate Total Return indicator for a return on bonds. The model, representing the return that should have been achieved by investors, returned a much more impressive 5.1% year on year.
While losing 2.1% in a year is disappointing, over 15 years it’s a disaster. Investigating the causes of the disparity has led Kaffe to focus on the two factors affecting investors: the performance of the fund invested in, and the timing of cash flowing in and out of these funds.
The UK fund market is a saturated place, with investors facing a dizzying array of over 3,000 fund choices. When considering funds investors need to understand that not all funds are created equal – and that high management costs that can take a big chunk out of any portfolio. In fact, the report estimates that fund costs eat up 0.75% of these lost returns.
There are three costs the fund investor needs to consider, the annual management charge, other associated costs that make up the Total Expense Ratio (legal fees, auditor fees and other operational expenses) and dealing costs.
It’s true that over time investment costs have fallen, partially due to the increasing interest of the market to DIY investors, but fund charges are still taking a healthy proportion of potential portfolio gains and can be avoided by choosing funds with low charges.
Only human nature
The unpredictable nature of the market can stretch the patience of the most committed investor. Whether it’s the lure of a star fund manager or sustained losses from market unpredictability, the report shows it’s the DIY investor’s desire to chase the market that causes the most damage, eating up the remaining 1.35% of potential returns each year.
Exploring the reasons why, the report details how investors continue to buy high, in many cases wooed by a star fund manager’s historic successes, positive press coverage or the lure of supposedly easy gains.
Over 15 years it’s natural that the market will experience lows, as well as highs. Seemingly forgetting this, many investors are losing significantly from their decisions on moving money, selling low instead of waiting out the storm.
There are lots of lessons to learn here for all investors, with the report reinforcing the view that past performance doesn’t indicate future success.
Time in the market
At this point, it’s clear that the average investor is losing out every year, but what can they do? It may be an investing aphorism, but the research clearly shows that timing the market won’t work, it’s time in the market that matters.
For the average investor, research from the US – and now the UK – shows that investing in a range of low cost funds, with a simple buy-and-hold strategy is likely to return more than an active strategy.
Chasing the market won’t just take up your time, it could eat up your gains too. Read more from the report here.