Investors Still Need to Mind the Gap in Their Funds’ Returns

Are you getting the most out of your fund’s performance?

Why It Matters: Over the past 10 years, the average dollar invested in US mutual funds and exchange-traded funds earned 1.2% less per year than what those funds returned during the same period. That’s the top-line finding in this year’s Mind the Gap study, which aims to address the question of where investors succeeded in capturing most of their funds’ returns, and where they fell short. Jeff Ptak, a managing director for Morningstar Research Services, breaks down the takeaways from the report and what investors can do if they want to avoid leaving money on the table.

11 Questions on the Mind the Gap Study

1. How does the report measure the difference between investor returns and total returns?
2. How does the latest research compare with previous years? Is the “gap” going away?
3. This difference in investor returns and total returns doesn’t just come from people failing to time the market. What else might cause the gap?
4. Where have investors been able to capture most of their funds’ total returns, and where have they fallen short? Are there certain categories that stand out?
5. Exchange-traded funds continue to gain popularity and market share. Did the investment type, mutual fund or ETF, make a difference in investor outcomes?
6. Morningstar research has found that active funds have largely struggled to beat their benchmarks, but certain categories are better suited for active management than others. Is there a difference in the investor return gap in active versus passive funds?
7. The study found that the more investors traded, the less they made. Why is that?
8. Morningstar has found that fees tend to be a predictor of performance. Does that finding hold when looking at investor returns?
9. The report also looked at the effects of return volatility. How did that translate to investor outcomes?
10. You’ve written that where a fund is utilized can be just as important as the type of fund and how it’s used. Can you explain that?
11. What is one takeaway from your research?

Key Quote on the Mind the Gap Study

The hotter a fund is to handle, that is, the more volatile its returns, even when we control for differences in types of funds, the less of that fund’s total returns investors capture. They get rattled. And so that can result in inopportune buying and selling. And so then they end up with wider gaps. So, the less volatile a fund was, or an ETF for that matter, was compared to other funds like it, the likelier investors were to capture that fund or ETF’s total returns. That is, the smaller the gap tended to be. And again and again, we have seen that in the study. And I think that’s something that certainly it’s advisable for investors to pay attention to.

The Takeaway: Less is more, automate as much as you can, and favor wide diversification. The more that we can automate, the more thoughtful and deliberate we can be about the context in which we place our investments, Jeff Ptak says. It’s fair to assume that the more buying and selling that we do as investors, the likelier it is to see these gaps between our dollar-weighted return and the return of our investments. What we should be deliberate about is just trying to find ways to avoid transacting, especially discretionary ad hoc transacting that takes place amid market turbulence.

More From Morningstar on the Mind the Gap Study

Investors are consistently earning less than their fund’s total return, and the gap isn’t going away. But some kinds of funds are more prone to return gaps than others. Read five key takeaways from the latest Mind the Gap report.

Bond-fund investors captured around half of their funds’ total returns, whereas investors in other types of funds captured far more. Put another way, the gap between the return of the average dollar invested in bond funds and those funds’ aggregate total return was far larger than it was for other fund types. Jeff Ptak explains the gap between bond funds’ investor returns and total returns.