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Bad Timing Costs Fund Investors

Sure, human beings — even some 401(k) investors — are often inclined to buy high and sell low. Morningstar puts some numbers on the costs of that behavior, and shows how it compounds over time.

In this study, Morningstar compared investor returns to a fund's total returns and found investors cost themselves between 0.74% and 1.32% per year by mistiming their purchases and sales of equity and bond funds during the 10-year period through Dec. 31, 2015.

In the annual study, Morningstar evaluated U.S. open-end mutual funds and calculated average asset-weighted investor returns and average total fund returns. Morningstar also tested four factors and their effect on investor returns: Morningstar Stewardship Grade, standard deviation, tracking error, and expense ratio.

They found that investors in allocation funds experienced the smallest gap between total returns and investor returns — 17 basis points — for the 10-year period through December 2015. Target-date funds are part of this mix, of course, and Morningstar notes that these “consistently show investor returns that are superior to time-weighted returns.” The report cites three reasons: First that TDFs have “sufficiently moderate” returns that avoid both scaring investors and attracting “hot” investments. Secondly these are generally held in 401(k) plans where investors buy in with every paycheck, and thirdly where investors tend to ride out the downturns.

They also found that:


  • Municipal bond fund investors lagged total returns the most, with a 132-basis-point gap. Here Morningstar cites as a problem the reality that this is a category with “very risk-averse” investors and “a sector with scary headlines” (Puerto Rican debt, Meredith Whitney’s ill-informed doomsday call).

  • Low-cost funds exhibit smaller gaps between total returns and investor returns than high-cost funds. Investor returns for the least-expensive quintile of all funds were 6.5% annualized in a five-year period compared with 6.39% for the average fund. However, the average investor in the priciest quintile of funds had returns of 3.43% annualized, compared with returns of 4.8% for the average fund, showing that the average investor in the least-expensive quintile nearly doubled returns of the average investor in the priciest quintile. The report notes that that margin can’t be explained by fee differences alone.

  • Investors fare better with shareholder-friendly firms. Funds with a Stewardship Grade of “A” saw investor returns beat total returns by 0.18%, while investor returns for funds with an “F” Stewardship Grade lagged total returns by 2.59%. The report notes that savvy investors tend to find their way to these type companies, that the better stewards tend to have lower fees, and also tend to be more careful about fund launches and “more forthright” in setting investor expectations.

  • When grouped by asset class, funds with higher volatility negatively affect investor returns. The most-volatile quintile of funds saw investor returns lag by 1.29%. Investor returns in the least-volatile quintile of funds beat total returns by 0.81%.

  • Investor returns lagged total returns of funds with high tracking error, which measures the extent to which a fund's returns vary from the benchmark, by 0.49%. Meanwhile, investor returns beat the total returns of funds with the lowest tracking error by 0.82%.


The whitepaper is available here.

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