Why There’s a 15% Gap Between Investor and Fund Returns

Advisors looking to persuade clients to avoid trying to time the market might point them to a new Morningstar report estimating that investors missed about 15% of their funds’ total returns for the decade ended December 2023.

Even thoughtful, steady investors can experience a lag between their total returns and fund performance, the research firm noted.

Morningstar estimates that the average dollar invested in U.S. mutual funds and exchange-traded funds earned 6.3% a year over that period, underperforming the average fund by 1.1 percentage points per year, assuming an initial lump-sum investment. Fund holdings generated about 7.3% a year, which Morningstar calls the buy-and-hold return.

The firm attributed the gap to mistimed buying and selling of mutual fund and ETF shares.

“In other words, investors failed to capture around 15% of their funds’ total returns, with that shortfall owing to the timing and magnitude of their purchases and sales,” Morningstar said in its annual “Mind the Gap” report, released last week.

“The gap was persistent. We found shortfalls between the average dollar’s return and the average buy-and-hold return in all 10 of the calendar years that comprised the 10-year study period,” Morningstar said.

“Investors particularly struggled to navigate 2020′s turbulence, adding monies in late 2019 and early 2020, then withdrawing nearly half a trillion dollars as markets fell, only to miss a portion of the subsequent rally.”

The gap reached negative 2% in 2020, Morningstar said.

Index mutual funds, meanwhile, produced almost no gap.

Consistent with prior findings, Morningstar found that allocation funds, which diversify assets widely across classes, produced the narrowest gap, at negative 0.4% a year. This suggests that investors have had more success using simple funds that automate routine tasks like rebalancing, the firm said.

“That means less transacting, and less transacting appears to have conferred higher dollar-weighted returns than otherwise,” Morningstar wrote.

Allocation funds are often used in defined-contribution plans, which mechanize investing, avoiding the potentially large timing costs investors can incur when making large, ad hoc transactions, the firm concluded.

“Conversely, sector equity funds had the widest gap — negative 2.6% gap annually — with at least some of that gap owing to the funds’ higher volatility, which our research suggests can trip up investors,” Morningstar said.