The last decade was a bucking bronco that threw off many investors.
The ideal situation for most fund investors is a nice steady upward climb. This way, just about any point that you buy in is a good one and you get positive reinforcement, which will encourage you to invest more.
Unfortunately, the aughts didn't give you that. For the broad market indexes, there were four years of double-digit losses and four years of double-digit gains with two years of single-digit gains sprinkled in. Those severe reversals are tough on fund investors who tend to read a lot into recent performance. The past two years were particularly challenging. The bear market of 2008 led to mass redemptions of equity funds just as those equity funds were primed for their best year of the decade. Ouch.
We now have data on Morningstar Investor Returns for the full decade so that we can see just how investors did and learn some lessons that will help you make more out of your investments.
How Do We Calculate Morningstar Investor Returns?
Investor returns tell you how the average investor in a fund fared. We take monthly cash inflows and outflows and then calculate the returns earned on those flows. As with an internal rate of return calculation, investor return is the constant monthly rate of return that makes the beginning assets equal to the ending assets with all monthly cash flows accounted for. The gap between investor returns and total returns shows you how well investors timed their purchases and sales. (For all the details on the calculation, you can check out the two-page fact sheet here or the 10-page methodology document here.)
Mind That Gap
To see how the average investor did overall, we calculated asset-weighted investor returns and then compared them with the category averages. A couple of years ago, doing this revealed that the average investor often did better than the average fund because, while their timing was off, they often picked bigger lower-cost funds. However, the whipsaw of the past two years has meant that, in most categories and in the aggregate, investors have done worse than the average fund.
You can see the summary data in this PDF.
The grand total for the average investor in all funds in the aughts was a 1.68% annualized return, compared with 3.18% for the average fund. The biggest gaps between investor returns and total returns were in municipal-bond funds, which returned 4.57% annualized. Investors only earned a 2.96% return. While the muni world's problems in 2008 got less attention than the stock meltdown, it was enough to lead some investors to redeem, only to see muni funds snap back in 2009.
In U.S. equities, the average investor earned a scant 0.22% annualized, compared with 1.59% for the average fund. As I noted above, two bear markets and two snap-back rallies made for a really challenging time for many fund investors.