Closing the gap between actual and total returns

Investors’ returns can fall short of reported total returns, but there are ways to help mitigate that outcome, says a Morningstar report released this week.

The U.S. data-based annual study of investors’ returns (dollar-weighted returns) found that investors earned about 7.7% per year on the average dollar they invested in mutual funds and ETFs over the 10 years ended Dec. 31, 2020. That result was about 1.7 percentage points less than the total returns generated by their fund investments over the same period, the report said.

The annual return gap is in line with those that Morningstar measured over the four previous rolling 10-year periods, during which results ranged from 1.6 to 1.8 percentage points per year.

The financial services company notes that its latest study used an asset-weighted methodology to calculate average total returns used as benchmarks, whereas in previous studies, an equally weighted methodology was used. The change led to more negative return gaps overall, the report said.

The latest return gap stems from “inopportunely timed purchases and sales of fund shares, which cost investors nearly one-sixth the return they would have earned if they had simply bought and held,” wrote portfolio strategist Amy Arnott and report author in a market update.

Investors in allocation funds continued to show the smallest gap, as in previous studies. Their dollar-weighted returns lagged the funds’ total returns by 69 basis points per year over the most recent 10-year period.

In contrast, investors struggled to use alternative funds successfully, the report said. The average dollar invested in alt funds lost about 0.3% annually over the 10-year period. That result was more than four percentage points lower per year than the funds’ total returns, and 12 percentage points per year less than the dollar-weighted returns for investors in U.S. equities funds — which had a 1.2 percentage-point annual return gap.

Investors in sector equity funds also fared poorly, as their dollar-weighted returns lagged the funds’ reported total returns by about four percentage points per year over the period.

The report suggested several ways that investors could improve their results: by embracing techniques that put investing on autopilot, such as dollar-cost averaging; by holding a small number of widely diversified funds; by avoiding narrower or highly volatile funds; and by automating mundane tasks like rebalancing.

For full details, access the Morningstar report online.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.