Private Investors Will Not Learn

In this article by Trustnet, private investors have yet again demonstrated their tendency to rely on past performance as the main factor when choosing investment funds. This is despite the warnings issued by the Financial Services Authority and the substantial body of evidence which shows how ineffective a method of selection this is.

The problem is that private investors use the same method for buying investments as they do when they buy anything else, such a car or a washing machine. They look up the specification, the performance characteristics and then they choose the one with the best performance. Unfortunately there really is no link between past and future performance, even for the so called better or 'top quartile' funds. Research has shown that the level of persistence of good performance amongst fund managers is so low as to make it pretty much a worthless exercise trying to choose on that basis.

Private investors, unfortunately also also succumb to the marketing hype issued by fund management companies, and believe that they can outperform the markets purely through the clever active management strategies adopted by their fund managers. The truth is that the majority of fund managers are barely able to achieve performance comparable to the markets in which they invest and most usually fail miserably. For this, active fund managers charge extra.

One particularly sad truth about this is that all too many financial advisers have failed to grasp the reality of investment and continue to peddle active strategies, despite the evidence to the contrary.

Smart investors concentrate on getting the asset allocation (the split between equities and bonds/cash) right and then invest via trackers and passives. They recognise that the only way in which to outperform the market is to take more risk, not to try and outfox it using the same information as is available to everyone else.

Smart investors adopt an Evidence Based Approach to investment!


Chris Wicks CFPI help you achieve your lifetime goals for reasons that are important to you

Is it possible to choose investment funds using past performance data?

Standard & Poors, a major fund rating agency has recently carried out research into tthe extent to which funds which have performed well in the past go on to doing so in the future.

The issue here is not whether active funds are capable of doing well. Some, undoubtedly are capable of generating good returns. The problem, as shown by the Standard & Poors, is that very few of the good performers go on to repeat their previous performance.

So what does this mean to private investors? For one thing it indicates that trying to build your portfolio using actively managed funds, no matter how much time and effort you or your adviser puts into choosing them, is likely to be a complete fools errand. You are likely to pay more for something (out performance) that you are very unlikely to get. In addition, if you are regularly swapping one fund for another on the strength of the poor performance of funds that you already hold in favour of ones that have done better over the same period, you will just be incurring extra costs and most probably spending time out of the market. This is one of the main reasons why large numbers of private investors substantially under perform the markets in which they invest.

The answer is to avoid the uncertainty and extra costs caused by active fund manager selection and instead to build the portfolio through index trackers and passive funds. This is, of course, the second step in the construction of a portfolio. The first is to ensure that you have adopted the correct asset allocation for your needs.

Chris Wicks CFPI help you achieve your lifetime goals for reasons that are important to you