Past proves poor guide to shares’ performance

THE average investor in managed funds has earned less than one third of the overall stockmarket return, a new US study has found.

The US stockmarket, measured by the S&P 500 Index, returned an impressive 16.3 per cent per annum between 1984 and 2000.

The annual return from the average managed equities fund was substantially lower at 13.1 per cent, according to the study by Vanguard Investments.

Most alarming of all, the annual return to the average equities fund investor was just 5.3 per cent.

The good news for investors is that the reasons for the poor returns have been identified, and therefore can be avoided in future.

John C Bogle, the founder of Vanguard Investments, says there are three main factors that detract from investor returns.

First, the cost of running the average “actively managed” fund is about 2.5 per cent. This directly reduces net returns to investors.

Second, most investors make the mistake of trying to time the market. They buy when the market is rising (stocks are expensive) and sell when the market is weak (stocks are cheap).

Third, investors buy on the basis of past performance, even though this is not a guide to future returns.

In other words, investors pour money into managed funds that have enjoyed a ‘purple patch’ then slowly discover, in many cases, that current returns are not so impressive.

Mr Bogle says the managed funds industry have contributed to this problem, since advertising by fund managers often focuses on past returns.

Investors also contribute to the problem because they allow emotions to cloud their judgement.

As a 50-year veteran of investment markets, Mr Bogle says “our emotions are almost always counter-productive”.

He has used the results of the study to promote the benefits of index investing, a concept that Vanguard pioneered in the US in the 1970s.

The aim of an index fund is simply to match the performance of the overall stock market (ie to match the index), such as the S&P/ASX 300 in Australia or the S&P 500 in the US. (See article below for more details.)

One of the features of index funds is that investors achieve instant diversification. They are not beholden to individual stock prices, nor to the performance of individual fund managers.

Index funds are also substantially cheaper to run, since the manager is not actively trading the portfolio.

Another key argument by promoters of index funds is that the performance of most actively managed funds averages out over time. Or to use the technical term, they revert to the mean.

In other words, very few funds consistently produce higher returns than the market average.

As Mr Bogle says: “Since so few investors will beat the market, own the market.

“Invest for the long run and do your best to ignore the swings of investor emotions that drive the speculative market swings in the short run.”

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