Private investors are followers of fashion. Just as “It” girls would not be seen dead without the latest Chloé handbag, so fund fashionistas feel that they must have the latest flavour-of-the-month product. But this can cost them dearly.

In the late 1990s technology funds were the must-have item and investors poured billions into them, only to see their value collapse by about 90 per cent after the bursting of the tech bubble in 2000.

More recently, commercial property funds were the runaway bestsellers of 2006 and early last year, pulling in hundreds of millions of pounds each month, only to fall sharply as the market peaked. Once again, investors who followed the herd ended up taking a tumble.

At the root of this mentality is a preoccupation with short-term performance. The reason why commercial property and technology funds became popular is because they boasted good recent track records. Between March 1998 and March 2000 technology funds trebled in value, while commercial property produced annual returns of more than 15 per cent in each of the three years from 2004 to 2006.

Christopher Traulsen, of Morningstar, the fund research group, says: “Investors all too often try to chase yesterday's winners. They then flee when the going gets rough. The net effect isn't pretty. Instead of buying low and selling high, investors end up doing the reverse - and they also incur needless charges for entering and exiting funds.”

The preoccupation with performance is fuelled by industry commentators, fund groups' marketing departments and, it has to be said, by members of the media. No financial publication is complete without a battery of statistics on fund performance.

To be fair, figures on consistent long-term performance can be significant - what is particularly dangerous is a focus on short-term performance, meaning anything up to about three years. Mr Traulsen says: “When evaluating the performance of a fund, we look to see how it has fared across entire market cycles and in different market environments. I would not consider a timespan of less than three years to be indicative of anything - and even three years is too short to be of much use.”

Mr Traulsen says that investors' natural tendency towards short-termism is exacerbated by the actions of some fund groups, which market funds on the back of a couple of years of good performance, frequently luring investors into a sector precisely when it is about to peak. Many fund groups are reluctant to provide data going back much beyond 12 months. “If you want to know who ran the fund five years ago or what its holdings were during a particularly rough period, you are almost always out of luck,” Mr Traulsen says.

Morningstar has studied the impact of the short-term approach on investor returns. It found that, in general, investors tend to pile into a fund after it has produced a good burst of performance and then experience much flatter returns. For example, a fund that rises in price by 20 per cent over a year might have rocketed by 20 per cent in the first six months and then stayed static for the remainder of the year. Only investors who held the fund for the entire 12 months would have obtained the 20 per cent return. The large number who invested only after the impressive showing of the first six months would have achieved a zero return on their holding, even though the fund had a good one-year track record.

In the speciality-technology sector in the US, Morningstar found that the average fund returned 3.25 per cent on an annualised basis over the past ten years, but the typical investor actually lost 5.04 per cent. In other words, individuals gave up an average of 8.3 per cent in returns annually because of their poor timing. The same pattern emerged in the Latin American sector, where private investors lost, on average, a hefty 6.1 per cent annually through poor timing.

The same thing has been happening in the UK. Lukas Schneider, of Dimensional Fund Advisers, the fund manager, completed a study recently of fund performance in this country. He says: “In the period from 1992 to 2003 the average UK equity-fund return was 6.93 per cent while the average UK equity-fund investor achieved an average annual return of 4.91 per cent - about two percentage points lower than the funds he was invested in.”

Mr Schneider says that the explanation for this performance gap is that the fund figures assume that investors buy and hold the relevant funds for the entire timespan studied. But what investors actually do is move in and out of funds. When returns to investors are measured in a way that reflects this, known as an asset-weighted return, the figures are consistently lower than the stated fund returns.

Mr Schneider adds: “The picture is even worse when you consider that most UK equity funds do not match the performance of the the FTSE all-share index, which beat fund returns by two percentage points. So UK fund investor returns are four percentage points behind that of the FTSE all-share. Investors could improve returns considerably simply by doing two things. First, by adopting a rigorous buy-and-hold strategy and not moving in and out of funds. Secondly, by purchasing index funds which, over the long term, tend to produce better performance, with lower costs, than conventional equity funds.”

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