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By Christine Benz and John Rekenthaler | 07-22-2013 12:00 PM

Where Are Investors Chasing Their Tails?

Morningstar's investor return data can reveal which types of funds investors are using well, and which they are using poorly with mistimed purchases and sales.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

Morningstar's investor return data show that investors systematically undermine their own results with poor timing. Joining me to discuss that topic is John Rekenthaler; he is vice president of Research for Morningstar. John, thank you so much for being here.

John Rekenthaler: Good day again, Christine.

Benz: John, let's talk about our investor return data. First can you give us just an overview of how we calculate those numbers?

Rekenthaler: Sure. The standard return that you see for a mutual fund is called time-weighted return, and it doesn't measure how much money is in a fund at a given time. So, if a fund is very small and has, say, terrific performance, that performance counts just as much for the calculations as if the fund is very large. So, it doesn't look at the asset base.

Investor returns, however, does look at the asset base, because investor returns are what you need to know--did people actually make money on this fund?

Let's take a simple example: you have $1,000 in an investment, and it doubles over the next year; you just made a $1,000 profit. So, then you put $8,000 more into the fund. So, there is $10,000 in your investment, it drops in value in half. You went from up a 100% one year, you went down 50% the next year.

So, according to the Morningstar calculations, and everyone's standard total return calculations, that fund broke even, but you made $1,000 in the first year, and you lost half of your assets, or $5,000, the next year, down $4,000. So, standard numbers say it's break-even, but you're out $4,000 because you had more money in when the fund performed poorly than you did when the fund performed well.

Benz: And that's a trend we see a lot.

Rekenthaler: That's a trend we see a lot, and that's the way to think of investor returns: Are people timing their purchases correctly, because if you compare investor returns to what the standard total return calculations do, investor returns should match the standard calculations if [investors'] timing is neutral. If you just sort of randomly put new money in, and turned it into darts and just threw it at the wall, investor returns should match the total returns. If you see that the investor returns are less than the total returns overall, people are systematically making mistakes. If they're better overall, then they're systematically getting it right.

Benz: So, investors can see on Morningstar.com the investor return data on a fund by fund basis. But I think it gets a little more interesting when you look at some of the categories and some of the asset classes, and we can observe some trends about what investors tend to do. And when you look at that data, John, do you see that any types of funds tend to be exceptionally poor in terms of investor returns, so their timing tends to be horrible? And on the flip side, are there any categories where you see that investors do really well.

Let's start with the losers, where investors' timing tends to be really bad.

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