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When Your Fund's Return Doesn't Match Your Earnings

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. We recently updated our annual study of U.S. investor returns. And here today to talk about some of the key takeaways is Amy Arnott. Amy is a portfolio strategist at Morningstar. Amy, thanks for joining me today.

Amy Arnott: Happy to be here. Thank you.

Dziubinski: Amy, before we dig into the results, can you talk a little bit about investor returns and why Morningstar looks at them every year?

Arnott: Sure. So, an investor return is basically the return that you would actually earn after adjusting for cash inflows and outflows into a fund. And in almost every case, the return you actually earn is going to be different from a fund's total return. The fund's reported total return assumes that you took a lump sum and invested it at the beginning of the period, and then held it throughout the entire time period. But most investors, they are investing in 401(k) plans or investing gradually over time. So we look at the difference between the actual results and the reported total returns to see how big those gaps are over time.

Dziubinski: Now it seems like we've seen, over time, some improvement in these investor returns. Lets talk a little bit about the trends over time.

Arnott: Yeah, we've definitely seen a positive trend. Looking back over the past five years, if you go back five years ago, investors were losing about 60 basis points on average because of the timing of their cash flows. And we've really seen that gap narrow significantly. So that for this most recent period, ending in 2019, investor returns overall were almost exactly in line with the reported total returns.

Dziubinski: Wow. And it also seems like one finding we've seen is that, in general, investors in those categories with the most assets have had pretty narrow gaps in investor returns. And that seems like a good thing.

Arnott: That's right. Yeah. We saw the best results for category groups like U.S. equity funds and allocation funds, which invest in a mix of stocks and bonds. And those are also areas that have the most investor assets. So that has also helped the overall results.

Dziubinski: But there's still probably areas, right, where investors aren't doing as well and maybe investing a little poorly from a timing perspective? What are those pockets?

Arnott: Some of the problems spots that we continued to see were in category groups like sector equity funds and alternatives, which tend to be much more difficult to use. We've also seen a pattern there, where investors tend to pile in after a period of strong performance and then head for the exits after things turn south. So definitely some areas that seem to be more difficult for investors to use effectively.

Dziubinski: Now for the first time this year, we took dollar-cost averaging into account in the study. Specifically, we wanted to see how returns would look if there was a consistent monthly inflow into funds. What did you see there, and what's the key takeaway there for an investor?

Arnott: The dollar-cost averaging results really reinforced the overall results we saw. And the pattern was, for areas that had positive investor returns, investors would have actually done worse taking a dollar-cost averaging approach. And on the flip side, areas where investor return gaps were more negative would have done better if investors had just invested a little bit at a time.

Dziubinski: Given those results and everything we've seen in the study, what are the key messages for investors from this research? It sounds like they're not behaving that badly across the board?

Arnott: Right. And there are a lot of different factors that go into the numbers. A lot of it depends on, What's the pattern of returns that you're experiencing? And how does that match up with your investment patterns? But overall, aside from a few problem spots, we don't see a lot of evidence that there's widespread market-timing or that the majority of investors are misusing funds and not getting good results. Overall, we saw that the results were pretty good.

Dziubinski: Well, that's terrific news. That's what we want: investors to be making the right decisions with their money. Amy, thank you for your time today and helping unpack these results for us.

Arnott: Sure. It's great to be here.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.