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%).