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Fund Spy

The Remarkable Gap Between Winners and Losers -- Page 2

Put a little time into your fund selection, and you'll be on the right side of the 'St. Hubbins line.'

Welcome to Lake Wobegon
Lest you think that finding better funds is a daunting task, consider this: The average fund investor actually does better than the average fund, despite making key errors. Yes, that sounds like Lake Wobegon where everyone is above average, but it's just a matter of two different averages. It does seem hard to believe, considering that many fund investors are lousy timers. They buy hot sectors after they have gone up a lot, and they panic and sell poor-performing sectors just before they rally. Yet they actually compensate for their bad timing by picking above-average funds.

In 2006, I used asset-weighting to find out how the typical investor did. That means I weighted fund returns based on asset size at the end of each month. When you do that, you see that investors typically fare worse than the actual stated returns for a fund because of lousy timing of purchases and sales. In fact, I first wrote about this in a Morningstar FundInvestor commentary titled "Mind the Gap" published in 2005. Financial pundits ate this up with a spoon because it made fund companies and fund investors look bad, and justifiably so.

But in a 2006 study, I took the extra step of asset-weighting those investor returns so that I could see how the average investor did overall. It turns out that collectively, fund investors actually did better than the average category performance because they chose better-than-average funds (see the figure below).

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