Understanding Average Returns
If you have been investing for any period of time, I’m sure you would noticed that the average return of any fund does not usually equal your average return . Why is that so?
For your information, the average return of a fund is taken from the begining of a period (usually the 1 Jan) to the end of the period (usually 31 Dec). This assume no further buying or selling during the period. Investor returns on the other hand are your real life returns that you actually receive.
See the diagram below. Even though the fund below gave say 10% return for the year (from Jan to Dec), it would have been very different if you invested at Point 1 vs Point 2.
From a study conducted by Dalbar Inc. from 1985 to 2004, they found that
the average mutual fund investor achieved is a 3.7% annualized return while the S&P500 achieved a return of 11.9% and inflation averaged 3%.
According to the study,
the reason for the average mutual fund investor’s low return was that these investors invested more in “Hot Performing” mutual funds at the end of bull markets and then became frightened and took money out of the market toward the end of bear markets.
In other words, the investors bought high and sold low; buying when prices are already high, saw the high returns, got tempted by what they see and invested. Shortly after, when markets are on a downward trend, they sold because of fear and not wanting to lose more, when they should be holding.
Financial planning is more of being a smart investor rather than chasing investments!
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