Are you checking your investment performance too often?

Lower fee trend rises among mutual funds and ETFs.
According to Morningstar’s latest study of US funds, market participants that are invested in mutual and exchange-traded funds (ETFs) paid less fees last year and saved approximately US$5.8 billion in overall fund expenses. The study further unveiled that the asset-weighted average expense ratio across all mutual and ETF funds in the US fell to 0.45% in 2019 from 0.48% in the previous year.

The move to low-cost funds has enabled a decline in asset-weighted average fees. According to the study, fees for active funds declined to an average of 0.67% in 2019 from 0.68% in 2018. One-fifth of the lowest-priced funds saw net inflows of US$581 billion in 2019, while the remaining funds experienced net outflows of US$224 billion.

“Investors are increasingly aware of the importance of minimising investment costs, which has led them towards low-cost funds and share classes,” said Morningstar.

Investors often focus on information that isn’t typically useful, such as recent performance. How does checking day-to-day performance hurt the performance of your investment?

Investment plans are long term. Although looking at performance statistics is a useful tool, one has to query how effective it is when investors start evaluating performance on a daily basis. We know growth assets can be very cyclical and go through periods of strong under-and outperformance, for various reasons. Therefore, past performance does not dictate future performance, which nullifies the merit of using short-term performance reports to gauge how well your investment is doing. Investors often expect future returns to resemble recent past returns, which in our experience is far less the case than the reality.

To invest successfully, it’s important to consider your risk tolerance. How much risk should you take when investing?

We believe working with an appropriately qualified financial planner is a very important aspect of investing, because successful investing requires a plan and plenty of discipline. Financial planning professionals will assist you in pulling the numbers behind your goals and perform a thorough analysis of your needs and risks. This simply means you cannot consider risk without goals, or goals without being cognisant of your risk tolerance.

What should investors then focus on?

The focus should be on long-term assessments of your portfolio performance relative to predetermined benchmarks and, even more importantly, your financial plan objectives. Often, these come with applicable investment horizons, which are critically important to consider when reviewing these numbers. When investing for growth, equity investing is often part of that portfolio composition, but to evaluate equity over a period of a few months can lead you down the wrong path. Currently, we have a good example on our hands, as markets have been under pressure since COVID-19 induced volatility entered markets late in February of last year, but if you consider the longer-term picture (as indicated in the graph below) returns have been in line with expectations.

Recency bias is widely understood as the tendency to overestimate the importance of recent events, and ignore long-term evidence. How can investors avoid succumbing to this bias?

It is crucial to remind yourself of your long-term investment goals. It is equally important to understand how asset classes will behave during your investment journey. Surprises create anxiety, which in turn often leads to mistakes. A solid plan, supported by realistic expectations over shorter and longer periods, will anchor your thinking and provide discipline to your investment process. Investors who create alignment between their portfolios and their long-term goals, and at the same time have realistic expectations of the instruments in their portfolios, have a far lower probability of being caught out by recency bias.

How regularly should performance be reviewed?

It is important to bear in mind that a regular review is a regulatory requirement. However, this does not mean you should evaluate all performances on a 12-month horizon, for example. What it does mean is that it’s important to check in with your financial planner to ensure you’re still on track to achieve your long-term investment goals. It also means that you can use the opportunity to get the reassurance you need to keep your anxieties in check, and to reinforce discipline in the investment approach. It is unbeknown to most investors that you can (and should) work on your discipline as an investor. We often hear financial planners say: “Stick to your plan.” That is exactly the type of discipline I’m referring to here.

While the recent past is a poor prophecy of what the future will be like, there are some valuable lessons we cannot ignore when considering longer periods of history. What can we learn from prior market declines?

We are definitely not saying all historical information is irrelevant. Information is a valuable tool and has a specific function to fulfil. Some numbers are more appropriate for short-term periods, whereas others require a longer-term mindset. In our opinion, recent performance is certainly of less value for growth assets. Long-term historical numbers are valuable, especially when considering asset class returns over time as historical valuations and trends. A practical example is how previous market declines helped us contextualise the COVID-19 crisis and to get a sense of what some recovery paths could look like, having considered previous market declines and pandemics.

Remember, market crashes occur far more often than what is believed over a long investment period, making these occurrences somewhat normal although uncomfortable. We’ve mentioned in previous publications that you can expect to experience a 10% setback every 18 months, and a 20%+ setback almost every five years, in equity markets. This shouldn’t come as a surprise. Investors need to understand that this is part of the journey; it needs to be part of your expectations. Without that context, investors cannot manage their expectations, and this is what leads to mistakes during periods of market stress.

What is the role of advisers in the current environment, given the increased levels of uncertainty?

We think the value of financial advice has increased dramatically during this period, as the probability that investors can make mistakes has increased. The probability of making mistakes increases during periods of market stress, as we have seen in recent months. The duty of any good fiduciary is to actively remind investors to focus on their long-term financial goals, and to encourage them to filter out the noise while riding out the storm.