“Investors lost out on about 15% of the return their funds generated” proclaimed Morningstar in its just-released 2024 Mind the Gap study, which highlights the issue of investors inadvertently losing out on potential investor returns by making poorly timed decisions.
“Investors lost out on about 15% of the return their funds generated” proclaimed Morningstar in its just-released 2024 Mind the Gap study, which highlights the issue of investors inadvertently losing out on potential investor returns by making poorly timed decisions. We have long used data from DALBAR and have published our own research on investor returns, so the report offered a look into data that’s difficult for us to access. Over a 10-year period ending on December 31, 2023, the average allocation investor earned 6.3% per year, while their funds produced a higher total return of 7.3%, resulting in a 1.1% performance gap. Domestic Equity investors earned 10.0%, compared with the expected 10.8% total return, a 0.8% return gap.
What is the Investor Returns Gap?
The “return gap” refers to the difference between a fund’s reported total return and the actual return investors experience, which accounts for cash inflows and outflows. An investor making a lump-sum investment should earn the fund’s total return. Transactions after the initial investment (including mistimed buy and sell decisions) impact the investor’s experienced returns. Morningstar notes transactions are often prompted by market volatility and emotions.
Key Findings from the 2024 Mind the Gap Study on Investor Returns
1. Consistent Gaps Over Time: Investors faced a return gap in every calendar year of the study, with particularly sharp declines in 2020 during the COVID-19 pandemic. Morningstar explained that investors added money in 2019 and 2020, but withdrew it at an inopportune time, missing a portion of the subsequent rally.
2. Fund Types Matter: Fully or partially automated strategies like allocation funds, showed the narrowest gap (-0.4%). These funds are generally designed to be among the “set it and forget it” subset of investments. On the other hand, the exhibit above shows that sector equity funds had a much larger gap of -2.6%, which is likely do the nature of sector-level investing, trend-following, technical investing and momentum.
3. Volatility’s Role: Volatility, usually measured as standard deviation of returns, appeared to be correlated with larger return gaps. The idea is that more volatile investments saw larger return gaps, implying that volatility could be a trigger for additional trading activity. This jives with our 47 years and counting of experience at The Prudent Speculator.
Lessons Investors Can Apply to Their Portfolios
Simplicity: Our research, paired with data from DALBAR and Morningstar shows that investors focused on the long term do better than those that trade frequently. That’s not to say that big changes in prices shouldn’t trigger some portfolio updates–they should– but constant churn is deleterious to wealth and threatens to knock an investor off the path to long-term investment success. With the benefit of hindsight, investors that had money on the sidelines and put it to work during the pandemic have done quite well.
Time in the Market: The temptation to react to short-term market movements often results in losses. Volatility can spook investors and cause them to shuffle their investments without a sound basis, harming longer-term returns. We have always believed that time in the market trumps market timing and note that stocks are always climbing a Wall of Worry.
Volatility & Fees: A finding in this Morningstar report is that volatility had a larger impact on returns (in a negative way) than fees. Highly volatile funds can lead to erratic investment behavior, costing investors more in missed returns than higher fees would.
Our Take on the Morningstar Study
The 2024 Mind the Gap study offers a clear message: Investor behavior, particularly timing decisions, has a major impact on long-term returns. Diversified portfolios of stocks with a long-term time horizon would likely go a long way to keeping investors on the path to financial success.
To learn more about how we can manage your wealth, please see our Wealth Management page or reach out to Jason Clark, CFA at jclark@kovitz.com.
