These funds in theory delivered a 9.4% average annual total return for the decade that ended in December 2020. But the average investor in these funds only reaped only a 7.7% return, according to a new study by Morningstar. That gap in returns stems from poorly timed buying and selling by fund investors.
This difference may seem small, but it really adds up over time, notes the study’s author, Amy Arnott, a portfolio strategist at Morningstar. She provided the following example:
Consider a 50-year old with a $100,000 portfolio who is investing $10,000 throughout the year for 15 years and earns the same return each year. By age 65, this investor’s portfolio will be worth $1.095 million — or about 15% less than the $1.264 million it could be worth, had the investor mimicked the fund’s returns, according to Arnott’s calculations.
“People may not realize that the day-to-day buying and selling activity can have a significant impact on their results,” Arnott says. That’s because to achieve a fund’s published returns, you must invest a lump-sum at the beginning of the return period — and not touch it, she adds. “People have a tendency to buy and sell at the wrong time.”
By resisting the urge to sell during periods of volatility or trying to time the market when you buy in, you can achieve investment returns that more closely mirror a fund’s return. The performance gap widens significantly for more specialized, sector-oriented or thematic funds, which most investors should probably avoid in the first place, Arnott says.
Investors have fared far better by opting for plain-vanilla, broadly diversified funds that track broad market benchmarks, Arnott says. Even if it’s not viable to invest a lump-sum into the market at once, dollar-cost averaging — or investing the same amount of money at set intervals — can significantly improve your results, she adds.
The key is to avoid making short-term decisions with investments meant for long-term goals. “For most people, a buy-and-hold strategy is the best approach if you have the money to invest.”