The behaviour gap in a financial sense describes the gap between investment returns and investor returns. To put it in other words, this is the difference between what we should do with our investments and what we actually do.
The problem with investing is that emotions can take over and lead us to make unwise financial decisions. While it might seem to make sense to sell shares when everyone else is scared or to buy the hot new stock everyone is talking about, it isn’t rational. Chasing performance by trying to time the markets is never good investment behaviour. For one thing, the investor who can consistently pick better than average investments is as rare as a road in Ho Chi Minh City free of motorbikes! For another, with investment lows often followed by highs, there is a very real risk of missing out on the benefits of the upturn by mis-timing.
So how can we close the gap between investment returns and investor returns? Advisers can argue until the cows come home about whether this is best done with passive or active investment.
The passive approach involves investing in index funds i.e. those tied to an index such as the FTSE100. Passive investments mirror what the markets are doing and don’t seek to outperform. Investors buy and hold without paying any attention to market ups and downs. This strategy also means that an investor stays invested through bad times and good and the question of whether performance could have been better managed becomes irrelevant. The main advantages of passive investing are low management fees, easy diversification of a portfolio and low turnover but because capital is allocated according to the proportionate size of companies in an index, there will be occasions when investors are forced to mis-time.
Active investing, by contrast, is when investments are managed using experience, skill and research data regarding fund/manager performance and market conditions. The aim is to outperform the markets. Of course, investors can do this themselves but, given the resources in terms of time and information available to most ordinary investors, most hand the reins over to investment managers who are experts in their field.
Clearly there is a middle ground to tread between these two opposing approaches. While in general I believe that buying and holding makes sense, there are obvious benefits to selecting funds which are managed by competent managers, which offer high-level asset allocation to spread risk, which invest in exceptional global companies and which consistently deliver market-beating performance for long periods. Good professional investment managers are rather like experienced pilots – they let computers do most of the work but intervene when necessary.
The key with active management is to select a highly discretionary fund manager with a proven track record. Here at Infinity we work with Tilney (we are their exclusive partner in Asia), a company with a truly exceptional pedigree which delivers great results for our clients.
Working with Infinity gives you access not only to our unrivalled experience in helping expats to cover all bases when it comes to their financial planning requirements – including investing for retirement, education fee planning, insurance and estate planning – but also to one of the best investment management in the business. Contact us to find out more.
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