Fund Investors Reveal Their Lousy Timing

Buy high, sell low. That’s what the typical fund investor did over the past ten years.

How can I be certain of the accuracy of my sweeping claim? I have data to back it up. Morningstar calculated fund investor returns over the ten year period that ended December 31. The figures show that, on average, investor dollars returned an average of 2.5 percentage points per year less than the average mutual fund. The average open-end fund (excluding money-market funds) returned an annualized 7.3% over the period, while the average investor netted just 4.8% annualized

Investors actually do a pretty good job of identifying good, low-cost mutual funds. But they undo all that hard work with downright awful market timing.

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Over that ten-year period, investors’ market-timing moves were worse than usual because the markets were unusually volatile. Investors badly misjudged both the onset of the 2007-09 bear market and the start of the subsequent bull market on March 9, 2009.

Making matters much worse, investors got 2013 totally wrong. At the start of the year, they yanked money out of U.S. stock funds and poured it into bond funds and emerging-markets stock funds. U.S. stocks, of course, had a fabulous year, with Standard & Poor’s 500-stock index soaring 32.4%. Meanwhile, the MSCI Emerging Markets index fell 2.3%, and the Barclays U.S. Aggregate Bond index slipped 2.0%

Morningstar figures that for the ten years from 2003 through 2012, the average investor trailed the average fund by an average of 0.95 percentage point per year. That’s lousy, though not as bad as 2013, which was a banner year for bad timing.

But let’s back up a bit. How can Morningstar tell how the average investor did? The investment-research firm first measures the flows into and out of each fund on a monthly basis. Each dollar invested in a fund during a month gets credit for the monthly return of that fund. Add up all the numbers and you get a good estimate of how the average investor dollar, and hence the average investor, did.

Investors, not surprisingly, tend to do the worst with funds that are the most volatile. Sector funds are Exhibit A. For the ten-year period from 2004 through 2013, the average sector fund returned an annualized 9.5%. But the average investor in sector funds earned only 6.3% annualized--a gap of 3.2 percentage points per year, on average.

People did almost as poorly with foreign and global stock funds. These funds averaged an annualized 8.8%, compared with 5.8% for the average investor—a gap of 3.0 percentage points per year, on average.

Investors did best, thankfully, in U.S. stock funds; that’s where many investors have the lion’s share of their money. Over the past ten years, U.S. stock funds returned an annualized 8.2%, compared with 6.5% for the average investor—a shortfall of only 1.7 percentage points per year.

Surprisingly, investors also couldn’t keep up with bond funds, which tend to be much less volatile than stock funds. The average taxable bond fund returned an annualized 5.4% over the past ten years, but the average investor netted just 3.2%--a gap of 2.2 percentage points per year, on average.

What can an investor do to avoid undermining his or her performance? As with so many things in investing, the solution is simple in theory but not easy to put into effect. All you need to do is pick an allocation to stocks, bonds and cash—and stick with it.

In my view, the worst mistake investors make is to change course based on the news. You hear that the Russians have invaded Crimea and you think it’s time to cut back on Russian stocks, at the least, and perhaps on all European stocks, maybe even all stocks. You read that the U.S. economy may finally be picking up steam, and you decide to increase your allocation to stock funds. The urge to take action is nearly irresistible.

What people tend to forget is that when some geopolitical event occurs or when an important economic figure is released, it’s almost immediately reflected in share prices. The market isn’t perfectly efficient, but it’s pretty efficient at reflecting new developments—almost instantaneously. So unless you know something the market doesn’t, and investors almost never do, you’re better off sticking with your current allocations. Or as one of my favorite sayings has it: “Don’t just do something, stand there.”

Steve Goldberg is an investment adviser in the Washington, D.C., area.