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The simplicity of this investing method hides its power

Investing is simple. But keeping it simple, that’s the hard part. Especially when markets get choppy, the temptation to ‘do something’ creeps in. Tweak your portfolio. Time the market. Chase performance. Sound familiar?

But here’s the truth: great investors don’t get clever – they get consistent. Sounds easy. But in reality, doing nothing is one of the hardest parts of investing – especially when your portfolio dips and headlines scream panic.

That’s where single fund solutions, such as one-click multi-asset ETFs and target date funds, are coming to the fore as an antidote to complexity. These are ready-made, globally diversified total market portfolios of stocks and bonds designed to ride through multiple market cycles.

Minding the gap

Morningstar’s annual Mind the Gap report is a great tool to help figure out what's at stake. Its research is a sobering reminder of how costly it can be to tinker with a portfolio by estimating the gap between reported returns on managed funds and ETFs and the actual returns harvested by investors.

There is a startling difference between the two, which is directly attributable to the poor timing of investor purchases and sales.

Over the 10 years to December 2023 fund returns outperformed the average investor actual returns by 1.1% annually, largely due to investors’ performance chasing tendencies. A 1.1% reduction in returns is a sizable sum over one year and a crushing blow to a long-term retirement portfolio over 30 years of compounding returns.

Morningstar also looked at the prevalence of performance chasing drag across different fund type categories. Interestingly, multi-asset funds stand out from the pack as products where investors came closest to earning their full return and self-harmed the least (only 0.4% behind).

Turns out there are some good reasons why these one-click solutions come out ahead.

Superannuation clues

Everyone is happy to stay invested when markets are rising, but how can investors avoid the cost of panicking when things turn south?

The superannuation system gives us some clues. With its compulsory contributions and the prevalence of single fund investment management frameworks, super funds have delivered some world-leading pension results.

Super may have cracked the difficult problem of how to get people who say they are long-term investors to actually be long-term investors. And many Aussies are starting to adopt a similar mindset and investing approach for their non-super nest eggs.

The first Australian ‘one-click ETFs’ debuted in 2017. The category hit $1 billion in 2020 and has been growing at roughly 40% annually for the last five years. Which brings us to $6 billion today, after raking in $1 billion in new cash flow across the past 12 months alone.

One of the biggest benefits of a one-click portfolio is you cannot measure individual investments inside your portfolio. There is a big behavioural advantage in this, because when you can there is a tendency to look at the performance of each investment individually.

In a well-constructed balanced portfolio, some assets will always outperform and some will always underperform. And to assume that the under performers are bad because of a recent drop is an easy trap, because the whole is greater than the sum of its parts.

As the Mind the Gap report shows, there is a strong desire to get rid of underperformers at just the wrong time. This leads to the dreaded buy high and sell low pitfall. So in that sense, one-click solutions don’t give investors that opportunity to self-harm.

One-click funds also auto-rebalance, which ensures the desired asset allocation and risk level is maintained. With the added benefit of systematically selling high and buying low, rebalancing can actually add to expected returns when volatility hits.

These behavioural and automation benefits, paired with a dollar cost averaging contribution strategy, can put a portfolio on autopilot. Recurring contributions over a period average out the buying price and can further reduce the impact of market volatility.

There’s a common perception that successful investors are the ones that nimbly navigate each zig and zag in the market. But the evidence suggests otherwise, and Warren Buffett, arguably the greatest stock picker of all time, sums it up nicely: “Wall Street makes money off your activity. You make money off inactivity.”

One-click funds aren’t flashy, but don’t overlook the sophistication hiding behind their simplicity. Investing should be like planting a tree and watching it grow—not digging it up every time the weather changes.

 

Duncan Burns is Chief Investment Officer for Asia-Pacific at Vanguard Australia, a sponsor of Firstlinks. This article is for general information purposes only and does not consider the circumstances of any individual.

For more articles and papers from Vanguard Investments Australia, please click here.

 

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