MarketsMuse update courtesy of extract from 18 December edition of  Reuters, with reporting by James Saft

Here is the thing about investing: wherever you go, there you are.

Which is another way of saying that we carry our problems, weaknesses and foibles as investors around with us, no matter how we approach the discipline or what tools we use.

While the investment world is constantly creating new, opaque and high-cost ways of separating investors from a portion of their capital, avoiding the obvious land mines is far from a guarantee of success.

Because we are human, and as such unique mixtures of such winning attributes as overconfidence, risk-blindness and hyperactivity, we have the capacity to take even great investing ideas and turn them into losers.

Take exchange-traded funds, which surely must be one of the most investor-friendly innovations of the past 20 years. ETFs, and here I am talking about those which passively track an index, are just brilliant: they facilitate diversification while providing liquidity and all at a low cost. In theory ETFs are a tool which allow investors to overcome many of their most common errors, and as an investment vehicle they have surely contributed greatly to the fall in average fees.

Like a sharp knife in the hands of a careless child, however, index ETFs as used by most investors are powerful tools which do more harm than good.

That, at least, is the conclusion of one new study, which found that not only did ETFs, as used by actual investors, not improve performance but dragged returns lower by an economically significant amount.

The paper, by Utpal Bhattacharya of Hong Kong University of Science & Technology, Benjamin Loos and Andreas Hackethal of Goethe University and Steffen Meyer of Leibniz Universität, looked at outcomes for nearly 7,000 German investors between 2005 and 2010 who used index ETFs. The upshot: the average ETF investor sees his net raw return lowered by 2.1 percentage points annually, and with a lower risk-adjusted return as well. (here)

Not only that, but the ETF users managed to use ETFs in such a way as to make their portfolios less efficient, implying that they are not getting the diversification benefit that is one of the main points of index ETF investing. So how did these investors take a good tool and use it to nail their own feet to the floor? It wasn’t even so much that the investors used the wrong ETFs, picking the wrong asset class or over-paying in fees. Instead these investors lost more by playing, badly, at being

market-timers. Their fault was that they bought and sold at the wrong time, just like the human beings they are.

For the Saft’s entire article, click here