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Financial Planning > Behavioral Finance

Here's How Much Poorly Timed Trades Cost Fund Investors: Morningstar

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What You Need to Know

  • Investors earned about 9.3% per year in mutual funds and ETFs over a decade, while the funds themselves returned 11%.
  • Buying and holding or making regular investments should help investors narrow the gap, Morningstar says.
  • Holding a few broadly diversified funds rather than more volatile ones can help too.

Financial advisors looking to persuade clients to hold on to their mutual fund shares can offer fresh evidence from Morningstar, which released research Thursday showing that poorly timed transactions led investors to miss out on higher returns.

Over the 10 years ending Dec. 31, 2021, investors earned about 9.3% per year on the average dollar they invested in mutual funds and ETFs, according to a Morningstar study. That may be an enviable gain, but it landed short of the 11% total return their fund investments generated over the same period.

“This shortfall, or gap, stems from poorly timed purchases and sales of fund shares, which cost investors nearly one sixth the return they would have earned if they had simply bought and held,” the annual “Mind the Gap” study from Morningstar portfolio strategist Amy Arnott and other researchers said.

The 1.7 percentage point gap between investor and total returns is generally consistent with gaps that Morningstar found for the four previous rolling 10-year periods. 

“The persistent gap between the returns investors actually experience and reported total returns makes cash flow timing one of the most significant factors — along with investment costs and tax efficiency — that can influence an investor’s end results. But there are a few steps investors can take to improve their results,” Arnott said in commentary covering the report.

Investors may be able to capture more of their funds’ total returns, Morningstar suggested, by:

  • Owning a small number of widely diversified funds and avoiding narrower or highly volatile ones
  • Automating routine activities like setting asset allocation targets and periodic rebalancing
  • Adopting techniques like dollar-cost averaging — investing the same amount on a regular basis — that put investing on autopilot

“Investors can easily get caught in a cycle of analysis paralysis by fretting over how much to buy or sell at various times. The endless drumbeat of market and economic news can make it tempting — even for professional investors and financial advisors — to feel like they should be doing something to respond to shifting market conditions,” Arnott wrote.

“But for the most part, the time and energy that investors spend on trading decisions is wasted effort — and often counterproductive. Investors can improve their results by setting a rational asset allocation, buying low-cost funds and just sticking with the plan. It also makes sense to set a strict schedule for rebalancing, such as rebalancing once per year or when your portfolio’s allocations drift significantly away from target levels,” she said.

Investing a big lump sum and holding for the long term may produce the best results, but many investors don’t have the funds, said Arnott, who noted this method also requires discipline. Most investors can invest only smaller amounts of money at a time, she added. 

The study suggests that investors can significantly improve their results by making regular investments over time, she wrote. “While systematic investing may not be ideal compared with buy-and-hold investing, it can still improve investors’ actual results because it helps them avoid the pitfalls of poorly timed inflows and outflows,” said Arnott.

U.S. equity funds and taxable bond funds, the two largest types by net assets, experienced smaller gaps than the broad fund universe, while allocation funds, which combine stocks, bonds and other assets, continued to show the smallest gap, according to Morningstar.

Sector, nontraditional equity and international equity funds generated the widest differences between investor and fund returns, according to the report, which noted more volatile funds tend to result in the largest investor shortfalls.

The relationship between return gaps and fees was less apparent, according to Morningstar. While the least expensive U.S. stock funds had smaller gaps than the most expensive, the reverse held true for taxable bond and nontraditional equity funds, the firm noted.


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