Why Fund Investors Keep Getting It Wrong

Financial advisors have the chance to help them (finally) get it right, Morningstar research shows

Individual investors have a penchant to self-destruct. And the $15 trillion mutual fund marketplace is apparently one of their favorite playgrounds.

According to Morningstar, the 10-year gap between mutual fund returns and what investors actually earned rose to 2.49% in 2013 compared with just 0.95% in 2012. Put another way, the typical fund investor gained 4.8% over a 10-year period, whereas funds enjoyed an average return of 7.3%.   

Apparently, people still don’t understand the market isn’t their worst enemy; rather, it’s themselves. Impatience, lack of self-control, and knee-jerk reactions have devoured alive the investing public.

In the debate of mutual funds versus ETFs, it’s been inaccurately suggested by some fund proponents that ETFs, because of their intraday liquidity, induce people to always do the wrong thing at the wrong time. Au contraire!

A closer examination of the Morningstar fund investor statistics actually shows that undisciplined investor types will invariably find a path to financial suicide, regardless of what products they choose to buy.

Furthermore, the fairyland view that a robust asset allocation across a diversified portfolio of well-managed funds can somehow cure individuals from their self-destructive ways is a total farce. People cannot get their money right until they first get their minds right. Remember the movie "Cool Hand Luke"?

In which categories were fund investors the most proficient at not self-imploding?

The average 10-year return for U.S. stock funds versus fund investors’ 10-year asset weighted return had the smallest performance gap among all fund categories. That’s a good start, but still not good enough.

Investors in U.S. equity funds still trailed average fund returns by 1.6%. And if we include the performance drag of fund expenses and taxes, we easily approach a 3% annualized deficit! Morningstar’s Investor Returns attempt to measure the actual returns that fund investors got.

The gauge uses a fund’s performance return and adjusts for fund inflows and outflows to see how the typical shareholder really did. Thereafter, the investor returns are asset weighted.

Although picking the right funds is what most fund investors worry about, they actually do a decent job of the task. Data shows it’s poor market timing, not fund selection, that causes lackluster results.  

“We saw massive inflows to intermediate-bond funds in 2012 just before one of their worst years in the past 40 years. It's sort of like the way we saw huge inflows to equity funds in 2000 or huge redemptions in 2009 — too much rearview-mirror driving,” said Russel Kinnel, Director of Mutual Fund research at Morningstar.

Ultimately, disorderly people with disorderly investment habits lead to disorderly investment results.

 

 

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