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When Investors Misuse Quality Funds

Data show investors pile into and out of funds at the wrong times, and their returns suffer for it.

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Timing is everything in life, or so the saying goes. But when it comes to investing, timing--or attempting to time the market--can be a person's enemy. No one likes to be left out of a good thing, so when we hear of a hot stock or mutual fund, we want a piece of the action. But usually by the time we've heard about it, it's too late, and the gains that made the investment so attractive in hindsight lead us into an investment that underperforms once we get on board.

Among the most interesting data points available on is investor returns, which reflects actual investor experience with a fund as opposed to how the fund itself performed in isolation. A fund's total return depicts whatever returns its basket of securities earned from one given point in time to another. But not every investor was on board the fund for the whole time period, and that's what investor returns attempts to capture. We calculate investor returns by using fund inflow and outflow data and applying it to fund performance. We can then see how the average investor fared relative to the fund. To illustrate how total and investor returns can differ, consider a fund that gains 12% in the first three months of the year, then remains flat for the remainder. Its gain for the entire year is 12%. But what about the investor who, seeing the fund's hot early performance, jumps in during month number four? His or her return for the year is zero. As you can see, the difference between investor return and a fund's total return can be quite dramatic.   

Adam Zoll does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.