An interesting study analysed the quantum difference between investor returns and fund returns over a 20-year investing period. The gap between the fund’s returns versus what an average investor made stood at a stark 5% for equity investments. The same for debt funds was pegged at 0.40%. Notably, the gap is comparatively lower between SIP returns and fund returns.
Why does this gap occur?
The gap in actual returns is likely due to investor behaviour. Investor choices that affect the performance of your portfolio include trying to time the market, succumbing to recency bias when investing, chasing a trend, or simply choosing to exit the market when it’s temporarily down.
Indian investor behaviour and its impact on performance
Here we highlight some behavioural attributes of investors that hamper their portfolio’s overall performance.
As investors, we often fall for the famous dialogue ‘Risk hai toh Ishq hai.’ Yes, your risk tolerance, or how much risk you are willing to take when investing, will determine the growth rate of your investments. But, we also need to comprehend the close-knit relationship between time and money, where the longer the investment horizon, the greater the returns. Impatience often causes investors to jump in and out of investments without realizing the long-term impact of their decisions. Let’s start by getting the facts straight. Investing in equity pays off over the long term, which most investment planners will peg at 20 years.
Another reason to be patient and stick to long-term investments in equity is that the probability of beating inflation is far higher in the long run. The graph below shows that the historical probability (or odds) of outpacing inflation or generating positive returns from equity at various time horizons increases over time.
A research study was carried out over a 10-year investment horizon to understand how many months of performance contributed to a fund’s overall outperformance over the benchmark. It was found that a fund’s entire outperformance over the benchmark was accounted for by just six months. Most investors who missed investing during those six months in the decade would have seen subpar portfolio performance compared to the fund’s performance. Going back to graph 1, the difference in returns between investor returns versus SIP returns in equity funds stands at 1.4%. That is the benefit of spreading out your investments over a long period while maintaining consistency for your portfolio.
Amid rising interest rates, recession fears, and high inflation, investors are trying to forecast a stock market bottom. Investors tend to cut their notional losses into real ones by exiting during a market downturn. The noise in the market adds to the chaos. Unfortunately, investors are unaware of the financial market’s inherent cyclicality, which means they may miss essential rallies and the chance for a much higher return once the cycle shifts.
Investors’ behaviour patterns are a crucial component that detracts from the performance of their portfolios. People tend to follow the herd. For instance, when a prominent investor sells a particular stock and makes headlines, retail investors follow suit to copy their move without rationalizing why. In all probability, the prominent investor had met his set goals and time horizon for that specific investment, leading to his exit. This might not have been the case for the individual investor who followed his move. Similarly, loss aversion may lead an investor to miss the bus on an excellent investment opportunity. Our behavioural biases significantly influence our critical decisions, ultimately affecting how well our portfolio performs.
The key takeaways here are:
- Historically proven, equity markets perform best in the long run, so stay invested.
- You should develop and adhere to an investment strategy based on your financial situation and risk tolerance.
- Be patient, disciplined, and alert while managing your investment portfolio, and avoid biases.
- To ensure to are well-equipped with the proper knowledge to make informed decisions check in with an expert periodically.