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Mind the Gap 2011

Fund investors have been buying and selling at the wrong times lately.

Russel Kinnel, 04/19/2011

Fund investors have been buying and selling at the wrong times lately.

The latest figures on investor returns confirm it, but it's no surprise. Large flows from equity funds to bond funds in the past couple of years have meant that investors who did make changes were generally going the wrong way. Sure, huge sums remained in equity funds and participated fully in the rally that began two years ago. However, the money that did move was mostly selling low and buying high. For pretty much all of 2009 and 2010, bond funds had net inflows and stock funds had net outflows.

To see what impact these moves had on investors' wallets, we turn to Morningstar Investor Returns. Investor returns are calculated by adjusting a fund's returns to reflect inflows and outflows. We then asset-weight those individual funds' investor returns to arrive at a figure that tells us how the average investor fared in an asset class. We can then compare those numbers with the average fund and see which fared better. Morningstar director of personal finance Christine Benz put it this way: "A fund's investor return takes into account the fact that not all of a fund's investors bought it at the beginning of a period and held it until the end. To use a simple example of investor returns in action, assume a fund generated a 10% total return in a calendar year, with most of those gains coming in the year's first quarter. If investors added substantial sums of money to the fund after its first-quarter runup, the fund's investor returns for that year would be lower than the fund's 10% total return."

We have calculated the data for the trailing one-, three-, five-, and 10-year returns ended Dec. 31, 2010. It's clear the market's swings in recent years have been hard on some fund investors. Compared with our study ended 2009, the gaps between total returns and investor returns are growing in those trailing periods except for the 10-year period. Why? The 10-year figure loses the year 2000, which was one of the worst years for investor returns. Back then, people were buying growth stocks and selling everything else just in time for a bad decade for growth stocks.

Let's take a look at the latest batch of data.

In 2010, the average domestic fund earned a return of 18.7% compared with 16.7% for the average fund investor, making for a gap of 200 basis points. For the trailing three years, that gap was 128 basis points. For the past five years, it was 98 basis points, and for the past 10, it was 47 basis points.

For taxable bonds, the return gaps were 138 basis points for one year, 52 basis points for three years, 57 basis points for five years, and 106 basis points for 10 years. That 10-year figure is pretty large considering it meant that returns fell to 4.47% annualized from 5.53%. Municipal bonds have consistently had an even bigger gap ranging from 113 basis points last year to 173 annualized for the trailing 10 years.

Balanced funds were the main bright spot. The gap for the past year was just 14 basis points, and it was only 8 for the past three years. Best of all, the gap went the other way for the trailing 10 years as the average balanced-fund investor outperformed the average balanced fund by 30 basis points.

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