Once a year, Morningstar, an American financial services firm, publishes a study that measures how much buying and selling funds, as opposed to simply holding them, costs investors.
The 2023 edition of the study shows that over the past 10 years, investors made 6% a year by investing in funds, while the funds gained 7.7% a year. Investors lost to the funds they invested in by 1.7% a year.
The reason is bad timing. The natural reaction of many investors is to sell a fund after it has performed badly, and buy it after it has performed well. In fact, it would usually be better to do the opposite – invest after recent bad performance.
The Morningstar study also finds that the performance problem the typical investor faces is more severe if the fund is more volatile. Investors in the least volatile funds lost 0.9% a year to bad timing; investors in the most volatile funds, 1.9%.
Performance problems were also faced by investors in Value stock funds, small stock funds, and emerging markets funds. All these fund types tend to experience volatile returns. Only investors in Growth funds were able to match the underlying funds’ performance. Growth stocks had a smooth ride over the past 10 years and so those funds were easy to hold.
This phenomenon of investors attempting market timing by looking at recent past returns can be seen on eToro as well. If a Popular Investor has bad recent performance, they will lose copiers. Investors chasing recent performance – good or bad – will, however, underperform in the long run.
Our strategy is volatile and it is not easy to invest in. Morningstar warns, “the added volatility [concentrated] strategies entail cost investors any excess return they might have earned and then some.”
An investor in our – or any other – concentrated strategy will improve their returns if they keep in mind the results of the Morningstar study.