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How Does the Timing of Fund Selection and Sale Impact Investor Returns?

Our study dives deep into differences in investor returns

Russ Kinnel, Morningstar Research Services LLC

 

Bad timing can undermine good fund selection and substantially impact investor returns. To understand how much of a difference timing can make, and the factors that contribute to this discrepancy, we took a closer look at our investor-return data. 

In Morningstar Research Services’ annual paper, Mind the Gap, we evaluated investor returns to identify how the average dollar in a fund fared over a certain time period. After this period was over, we could see how much poor timing affected the average investor. The chart below shows that the average investor lost 45 basis points to timing over five 10-year periods ended December 2018. 

Source: Morningstar Direct and author’s calculations. Data through 12/31/2018. The average of total returns and investor returns over five 10-year periods shows modest gaps for all but alternatives.

Does volatility impact investors’ timing?

In addition to the difference in returns, we assessed the reasons investors made timing errors and how they fared when we grouped investments by expense ratio and volatility.

When we broke down funds within asset classes based on their standard deviation, our research revealed a consistent story. The chart below shows that funds in the least-volatile quintiles consistently had higher investor returns than those in more-volatile quintiles. (Though we sorted funds by Morningstar Category for other factors, we sorted within asset classes for this one because volatility differences within categories tend to be small.)

Source: Morningstar Direct and author’s calculations. Data as of 12/31/2018.

These findings suggest that “boring” funds work well because they aren’t as likely to inspire fear or greed. Also, timing simply has less impact on investor returns when a fund has lower standard deviation.  

A look at how fees impact investor returns 

Fees also provide a clear understanding of the gap in investment performance. As depicted in the chart below, low-cost funds tend to lead to higher total returns and higher investor returns. Costs can be good predictors of performance, so this makes intuitive sense. 

Source: Morningstar Direct and author’s calculations. Data as of 12/31/2018.

A second factor that could lead to higher investor returns is that low-cost funds attract savvier planners and individual investors who make better use of their funds.  

The chart also shows that investor returns are higher for cheaper funds and that the gap grows as funds increase in cost. This means that high-cost funds tend to create bad timing and lower returns, therefore emphasizing why cost should play a large role in fund selection

These findings reflect the first phase of our research, which focuses on U.S. investments. The upcoming global report, set for launch in October 2019, will provide additional insight and analysis. 

This report was done in collaboration with Maciej Kowara, Matias Möttölä, Chau Pham, and Timothy Strauts. 

To view the full analysis, download the Morningstar FundInvestor newsletter.

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The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission.

The Morningstar Analyst Rating should not be used as the sole basis in evaluating a fund. Morningstar Analyst Ratings are based on Morningstar's current expectations about future events; therefore, in no way does Morningstar represent ratings as a guarantee nor should they be viewed by an investor as such. Morningstar Analyst Ratings involve unknown risk and uncertainties, which may cause Morningstar's expectations not to occur or to differ significantly from what we expected.

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