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Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.

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Gaffs and Gaps

Hi Guys,

Generally, gaffs generate outcome gaps. We’re all painfully familiar with that investment world maxim.

We recognize that integrated over the entire marketplace, both individual and institutional investors must underperform market returns because of fees and cost leakage. From an individual investor perspective, a double whammy comes into play.

Not only does he absorb the return shortfalls (the first whammy) tied to underperforming active fund managers, he often contributes a second whammy himself by failing to even capture the already once attenuated returns earned by the funds he trades. He chooses to abandon ship with impeccably and predictably poor timing.

The typical investor is frequently labeled with faulty performance chasing. Morningstar’s Russell Kinnel has a likely alternate explanation: today’s investors are news chasing. We are captive to the 24/7 constant news cycle that prompts us to trade far too frequently, often with wealth compromising impacts. As investment timers, our composite track record just plain stinks. Sorry for that bluntness, but it is realistic.

Here’s a Link to a repeatedly updated “Mind the Gap” study by Morningstar’s Kinnel:

http://www.morningstar.com/advisor/t/88015528/mind-the-gap-2014.htm

Earlier versions of “Mind the Gap” studies covered different timeframes and differing period lengths with basically the same dismal trends. Changing losing behavior is a challenge for some folks, sadly, portfolio poor folks in the end.

The specific numbers change; the basic takeaway does not. In almost all fund categories and in almost all timeframes, the average amateur investor does not come close to securing market-like returns. The underperformance penalties are statistically significant and annually erode a portfolio’s net profits to a fraction of their potential. Kinnel’s work illustrates that finding.

The Kinnel studies are based directly on a huge body of empirical fund data. By itself, that constitutes a compelling argument for core Index investing. Kinnel arrives at that same conclusion. Vanguard has added to that argument with countless Monte Carlo-based analytical simulations. Here is the Link to that comprehensive analyses:

https://pressroom.vanguard.com/content/nonindexed/Quantifying_the_impact_of_chasing_fund_performance_July_2014.pdf

The Vanguard study too is grounded in the existing mutual fund database that is coupled to a set of simple trading rules. Certainly the stipulated rules govern the results, but they are logical and are a reasonable set that an investor might well accept and implement. It is somewhat surprising that both the Kinnel empirical work and the Vanguard Monte Carlo analyses collate so closely. They buttress each other. DALBAR reports similar results.

A wise old adage is that “if you find a problem, find a solution”. Investing advice need not be complicated to promote better outcomes. Indexing a portion of your portfolio, ignoring the daily news cycle, and staying the long-term course is simplicity itself. If applied, these commonsense steps could improve the investment returns of many folks. Of course, MFOers are excluded being immune to investing gaffs and return gaps. If only that were true!

But as Warren Buffett cautioned, “Investing is simple-but it is not easy”. Nothing worthwhile ever is.

Your comments on this matter are both encouraged and welcomed.

Best Regards.

Comments

  • Very informative. Thanks @MJG.

    This reminds me of a tale when a youngster was running through the grass towards the horizon. Unfortunately, when he arrived he discovered it was a large cliff and he was three steps past the edge.

    Sometimes caution is prudent when approaching certain points whether in life or investing.
  • edited March 2015
    "We are captive to the 24/7 constant news cycle that prompts us to trade far too frequently, often with wealth compromising impacts."

    Look at today. Mere hint that interest rates MAY rise and market gets obliterated to the tune of -300. It is very difficult to be a long-term investor when it feels as if the majority of market participants are operating on an increasingly shorter and shorter time frame. As I've noted before, the average holding period of a stock used to be years. Now it's days.

    Keep in mind that this has happened previously and rates didn't go up and secondly, I still think even if rates did go higher, it will be a very, very long time before we go back to the yields we saw pre-2008.
  • TedTed
    edited March 2015
    @ John Chisum: Bad link ! 'Mind The Gap'
    Regards,
    Ted

  • Hi Ted,

    Thanks for the heads-up.

    I've corrected the Link to Kinnel's work such that MFOers should gain access to at least the first page of his article. The first page contains the table that highlights the investor shortfalls relative to the funds that they buy and sell too often.

    Best Wishes.
  • Hi Scott,

    Thanks for your input.

    I agree that both investors and even professionals are operating on a much shorter and faster clock. The old timers would term this speculating and not investing. I remain an investor and did not know of the market downdraft until hours after it was in the record books. It will recover.

    I'm sure interest rates will rise as our recovery continues slowly and in jerks. The Fed will match this slow moving super-carrier's movements with incremental rate increases over an extended timeframe. It takes time to change a carrier's direction.

    I'm staying cool; I suspect you are also in that cohort. Doomsdayers and Cassandras alike do not prosper in the marketplace.

    Best Wishes.
  • edited March 2015
    @MJG

    You noted:

    1. "Morningstar’s Russell Kinnel has a likely alternate explanation: today’s investors are news chasing. We are captive to the 24/7 constant news cycle that prompts us to trade far too frequently, often with wealth compromising impacts. As investment timers, our composite track record just plain stinks. Sorry for that bluntness, but it is realistic."

    2. "A wise old adage is that “if you find a problem, find a solution”. Investing advice need not be complicated to promote better outcomes.Indexing a portion of your portfolio, ignoring the daily news cycle, and staying the long-term course is simplicity itself."
    >>>Obviously, investors and their experience; being their time in the "game" with their own money, varies. Their ability to absorb and use "news" will be limited by their own processes and experience.

    Many likely trade too often, to the bad side of positive investment returns; based upon market noise.

    However, the so-called daily/weekly/monthly news chasing or noise offers a base of information upon which one may form a process for investing. It is to the person to determine how to use the "news chasing or what I name as "monitoring".

    As a base of information builds over time, an investor should be able to establish a much improved method for reasoning their investment choices.

    Not unlike building a base of knowledge in math or whatever subject area one chooses to use for an example; a student may consider the daily grind of learning subject matter to be "boring, useless or so much noise". But, we know all of this daily "chasing" of the subject is to build a base from which to expand to a higher level of knowledge.

    Long term investing should always be the goal, of course. But, long term investing may be a series of shorter term investments, for some, that do not remain static; but dynamic. Many here, based upon my recall, have longer term, core investments; but there are also those who supplement this with a portion of their portfolio that is dynamic.

    One may only use their own success and confidence with the various choices available today; to determine their forward investments paths. Absorbing investment news on a short term basis (daily) basis may allow one to build a base of knowledge over time that will allow better decision making in the future. What may appear to some as a "knee-jerk" investment is really a consolidation of actionable news over a long time period.

    Hell, many investors have been waiting for 6 years watching Europe and wondering what will become of their markets. There have been many head fakes over these years for the European equity areas in general.

    Has the Euro finally started a meaningful path to parity??? The slow decline of value in the Euro v the dollar over the past year had continued to be offset by other problems in Europe regarding equity sectors, IMO. Is this "problem" beginning to be removed?

    We'll hang around with some money in this area, until we hopefully discover early enough, that it is time to leave. Being the price trend of the underlying investments.

    Euro/$

    Regards,
    Catch
  • MJG
    edited March 2015
    Hi Catch22,

    Thank you so much for your thoughtful contribution.

    I concur that investing knowledge is a key to success along with patience and discipline. The knowledge portion is accumulated over time, study, practice, and experiences.

    It is not clear to me that a 25 hour per day and an 8 out of 7 day work week commitment is the efficient way to accumulate the requisite knowledge base. The daily noise tends to overwhelm the useful signals, and makes the learning process more difficult. The challenge is to find a comfortable balance. As you noted, that balance point is likely different for each and every investor.

    The Euro and the Euro Union are separate issues that always invite heated debate. The Euro members are sufficiently different that a common currency among 17 diverse members would likely remain a constant problem. I’m surely not an expert, but I don’t anticipate any miracle resolutions soon, or even ever. The Brits made a good decision not to play the single currency game.

    My Best Wishes to you and your family.
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