The average dollar invested in U.S. mutual funds and ETFs earned 6.3% per year during the 10 years ending Dec. 31, 2023, which was about 1.1 percentage points less than the funds performed during the same time period, Morningstar says in a new report that blames the performance gap on bad investment timing.
The gap meant that investors lost out on about 15% of their funds’ performance during the 10-year period, Morningstar said in its annual “Mind the Gap” study.
The performance gap for investors “was persistent” and created 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, said Jeffrey Ptak, chief ratings officer for Morningstar Research Services.
The study compares the average investor’s return on investments in funds and exchange-traded funds (ETFs) with the average fund’s actual total return. Morningstar attributes any difference in performance to the timing of when investors bought or sold shares.
“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,” Ptak reported. That bad timing cost investors a negative 2% gap that year.
The 15 percentage-point gap, or 1.1 percentage-point average annual performance gap, is down from gaps ranging from 15 to 17 percentage points from 2018 to 2020, but still suggests that timing costs are a persistent drag on the returns investors earn, researchers found.
“Drilling down, we found allocation funds, which diversify their assets widely across asset classes, boasted the narrowest gap (negative 0.4% gap per year). This is consistent with our prior findings, suggesting investors have had more success using simple funds that automate routine tasks like rebalancing,” Ptak said.
Conversely, sector equity funds produced the widest gap (a negative 2.6 percentage-point gap annually), with at least some of performance lag due to the funds’ higher volatility, which Morningstar research suggested “can trip up investors.”
“The more volatile a fund’s returns versus peers, the larger the gaps tended to be. The average dollar invested in the most volatile sector equity funds lagged the buy-and-hold return by over 7% per year,” Ptak noted.
U.S. stock funds earned the highest investor return, 10.0% per year, will netting investors a negative 0.8% gap. Conversely, alternative funds produced the lowest returns at a negative 0.2% annually, resulting in a negative 0.6% gap for investors.
Among the largest fund categories by assets, the foreign large-blend category exhibited no gap, while large-value funds produced the widest with a negative 0.9 percentage-point gap annually, Morningstar reported.
Gaps were generally narrower for open-end funds than ETFs, the firm found. Open-end funds earned a 6.1% investor return per year (while producing a negative one-point gap gap) while ETFs earned 6.9% (resulting in a negative 1.1 point gap).
The average dollar invested in index funds earned a 7.6% annual return (negative 0.8 point gap) compared with 5.5% per year in active funds ( negative 1.2 point gap).
While there was a small gap for index mutual funds over the 10-year period (a negative 0.2 point year), the gap grew for index ETFs, “where the average dollar earned 1.1% less per year than the buy-and hold return,” Morningstar reported.
Morningstar also compared active funds with index funds, finding the gap was slightly wider for the average dollar invested in active funds (a negative 1.2 point gap) than index funds (a negative 0.8 point gap).
Morningstar said one takeaway from the findings is that “less is more.”
“investors seem to have enjoyed greater success using widely diversified, all-in-one allocation funds, capturing most of these funds’ returns. And why? There are multiple reasons, but these strategies automate mundane tasks like rebalancing. That means less transacting, and less transacting appears to have conferred higher dollar-weighted returns than otherwise,” Ptak said.
Fees also matter, to a point, Ptak said. “Investors have ample reason to choose low-cost funds, which are far likelier to earn higher total returns in the future. But we didn’t find a strong link between fees and investor return gaps in the study,” he said.
“You can pick the cheapest of a hard-to-use fund type and still come up well shy of earning its total return by transacting inopportunely,” Ptak warned.
While index mutual funds had almost no gap, the average dollar invested in index ETFs lagged the buy-and-hold return by more than one percentage point a year, a difference worth monitoring, he said.
