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Portfolio > Portfolio Construction > Investment Strategies

Morningstar Report Shows Why Investors Need Professional Advice

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What You Need to Know

  • The Mind the Gap report showcases the gap between what investors earn from mutual funds and ETFs vs. what the funds report.
  • Investors earned an average 7.7% per year over the 10 years ended Dec. 31, 2020, vs. a 9.4% average reported by funds.
  • The biggest gaps were in alternative and sector equity funds; the smallest, in asset allocation and core bond funds.

Morningstar’s latest annual “Mind the Gap” report, comparing investors’ returns from mutual funds and ETFs with the returns that funds report, supports the view that investors could use the help of professional financial advisors.

“Bad decisions such as trading too often, buying funds after they’ve already run up, and selling in a panic after market declines can all chip away at investor returns,” according to the report.

The report found that investors earned an average 7.7% per year on their mutual fund and ETF investments over the 10 years ended Dec. 31, 2020, compared with a 9.4% average total return generated by the funds themselves.

The 1.7 percentage-point gap means investors gave up about one-sixth of the return they would have earned if they had just bought, then sold the fund shares. The report used an asset-weighted methodology to calculate these averages.

The Biggest and Smallest Gaps

Morningstar found the biggest gaps in returns involved alternative and sector equity funds, which generated about 4 percentage points more on average than what investors had collected.

“Sector funds are particularly prone to performance chasing, with investors often piling into popular sectors after a strong showing and then bailing out when they fall out of favor,” according to Morningstar.

Alternative funds, which had relatively low returns of just 4% annually, were the most volatile and subject to greater trading activity.

“Investors in alternative, sector equity, and international-equity funds would have done significantly better by dollar-cost averaging,” Morningstar wrote.

But dollar-cost averaging has its drawbacks too.

“If returns are generally positive, investors are typically better off making a lump-sum investment and holding it for the entire period,” according to Morningstar. “Investors who buy and hold can take full advantage of performance trends when total returns are positive, but investors who contribute smaller amounts over time often have fewer dollars invested during periods with strong returns.”

The gap between investor and fund returns was smallest for allocation funds with 50% to 70% invested in stocks — 0.47% — and for intermediate core bond funds (0.38%).

Investors in core bond funds “aren’t as prone to poorly timed asset flows as other areas” because they tend to stick with core holdings, according to Morningstar. The same can be said for asset allocation funds, a favorite among buy-and-hold investors, according to Morningstar.

Tips for Investors

Morningstar concludes its report with these tips for investors:

Focus on holding a small number of plain vanilla, broadly diversified funds.

“More broadly defined offerings, such as U.S. equity and taxable-bond funds, have fared significantly better than narrower offerings, such as sector funds and alternatives.”

Automate mundane tasks such as setting asset-allocation targets and periodic rebalancing.

Set a rational asset allocation, buy low-cost funds and stick with the plan, setting a strict schedule for rebalancing, such as yearly, or when allocations drift significant from target levels.

Avoid narrow or highly volatile funds.

With a few exceptions, funds that expose investors to less volatility and are easier to own are less prone to erratic cash flows.

Embrace techniques that put investment decisions on autopilot.

This includes dollar-cost averaging, but investors who are able to buy and hold because they have the means and the temperament will likely enjoy the best results. Still, systematic investing “helps avoid the pitfalls of poorly timed inflows and outflows,” according to Morningstar.


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