FRONTLINE
Bad Timing Cost Fund Investors 17 % In Gains The Past Decade , Morningstar Says
The average fund gained about 7.7 % per year over the 10 years ended December 31 , 2022 , while the average dollar invested in mutual and exchange-traded funds earned a 6 % annual return . That 1.7 % gap turns into 17 % over 10 years — and it ’ s the result of the timing of investors ’ purchases and sales , according to Morningstar ’ s annual “ Mind the Gap ” study , released in late July . The study finds investors struggled to time cash flows into and out of their investments , which cost them .
As a result of when investors bought and sold their funds , “ investors missed out on about one-fifth of their fund investments ’ average net returns , a significant shortfall ,” wrote the study ’ s author , Jeffrey Ptak , chief ratings officer for Morningstar Research Services LLC .
The study compares the average investor ’ s return on investments in funds and exchange-traded funds and compares it with the average fund ’ s actual total return , attributing any difference to the timing of when investors bought or sold shares .
“ The smaller the gap , the more investors captured their funds ’ total returns and vice versa ,” Ptak wrote .
That 17 % gap “ is more or less in line with what we ’ ve found when estimating the dollar-weighted return gap for the 10-year periods ended December 2021 ( -1.7 % gap ), 2020 ( -1.7 %), 2019 ( -1.5 %) and 2018 ( -1.6 %), suggesting that timing costs are a persistent drag on the returns investors earn ,” he added .
When grouped by asset class , the only class in which investors outperformed the actual fund performance was in allocation funds , which Morningstar defines as equity funds that seek to provide both income and capital appreciation by investing in multiple asset classes including stocks , bonds and cash .
The average dollar invested in allocation funds gained 6 % per year over a 10-year period ended December 2022 , while there was a 6.4 % return for the average fund , a gap of 0.46 %— the narrowest gap of any asset class .
On the flip side , investors in narrower sector equity funds earned only 6.4 % per year on their dollar , which was 4.4 points less than the average fund ’ s 10.8 % total
The gap grew when investors selected alternative funds , where the average dollar lost almost 1 % per year while the average fund rose about 1 % per year .
return —“ a large deficit reflecting mistimed flows ,” Ptak wrote .
The average dollar invested in U . S . stock funds earned 11 % per year over the decade ended December 2022 .
Still , that means that the average dollar invested in U . S . stock funds lagged the return of the average fund by around 0.8 % per year over the 10 years ended December 2022 .
The gap grew when investors selected alternative funds , where the average dollar lost almost 1 % per year while the average fund rose about 1 % per year .
Morningstar also estimated the dollar-weighted returns of the 10 largest Morningstar categories by net assets over a 10-year period .
The average dollar invested in the most popular U . S . stock categories earned almost as much as the average fund , as evidenced by the relatively small gap for the large-cap blend category ( a mix of value and growth ). In contrast , investors actually beat out the market in the large-cap growth category . Investors trailed the large-cap blend return by just 0.59 % and actually beat out the large-cap growth performance by 0.10 %, Ptak found .
Similarly , the average dollar-weighted return of moderate-allocation funds nearly matched the average fund ’ s total return , falling behind in performance by only 0.29 %, Morningstar found .
Investors found it most difficult to effectively time their way into and out of more volatile funds .
“ One of the clearer takeaways from the study is that investors are more likely to mistime their investments in highly volatile funds than they are in less-volatile funds ,” Ptak wrote .
On average , the least volatile funds ’ dollar-weighted returns lagged their total returns by around 0.9 % per year , which was a full percentage point narrower than the gap for the most-volatile funds .
But the gap for riskier funds , such as alternative funds ranked in the highest volatility quintile by Morningstar , saw a
10 | FINANCIAL ADVISOR MAGAZINE | SEPTEMBER 2023 WWW . FA-MAG . COM