The Performance Gap

TL;DR

Investors underperform the market due to performance chasing, resulting in a gap between investor returns and investment returns. To improve, investors should avoid chasing past performance and focus on having a disciplined investment strategy.

Transcript

everybody wants their investments to outperform the market but most investors underperform for a simple reason they chase past performance investors get into investments after they have done well and out after they've done poorly resulting in a sizable gap between investor returns and investment returns I'm Ben Felix portfolio manager at PWL Capita... Read More

Key Insights

• ❓ Performance chasing is a persistent feature in financial markets, contributing to underperformance.
• 🌥️ The return gap is larger for growth-oriented funds compared to value-oriented funds.
• 🥺 Investors' return expectations are influenced by recent performance and valuations, leading to mistimed decisions.
• 😘 Diversified funds with poor factor exposures tend to experience outflows and lower valuations, creating higher expected returns.
• ⌛ Timing errors, particularly selling after a decline, contribute more to the overall performance gap.
• 💋 Having a disciplined investment strategy and sticking with it is crucial to avoid being influenced by attention-grabbing recent returns.
• 💓 Beating the market is challenging, but outperforming the average dollar invested in the market is relatively easier.

Questions & Answers

Q: Why do most investors underperform the market?

Most investors underperform the market because they engage in performance chasing, investing in assets that have recently performed well and selling after poor performance, resulting in a sizable gap between investor and investment returns.

Q: How much is the performance gap between investor returns and investment returns?

The performance gap can be between 1.5% and 2%, depending on the source. More volatile and specialized funds can have even larger gaps.

Q: Are fees the primary factor in underperformance?

While fees are important, data suggests that inopportune timing has a larger impact on underperformance. Investors lose more annually due to mistimed buying and selling decisions compared to the fees they pay.

Q: Why do investors engage in performance chasing?

Investors tend to extrapolate recent returns into the future, leading them to believe that assets with strong recent performance will continue to do well. This bias causes them to chase past performance and overlook other essential factors.

Summary & Key Takeaways

• Many investors underperform the market because they chase past performance, getting into investments after they have done well and getting out after they've done poorly.

• Performance chasing leads to a gap between investor returns and investment returns, which can be as high as 1.5% to 2%.

• While fees are important, investors lose more to inopportune timing, as they tend to have high return expectations when valuations are high and low expectations when valuations are low.