A close look at true investor returns yields some surprises.
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By Karen Dolan, CFA | 06-10-10 | 06:00 AM | Email Article

Your emotional response to the market's gyrations may be one of your biggest costs as an investor. The return lost to poor timing can even trump the cost of expense ratios. The average asset-weighted expense ratio across Morningstar's database of mutual funds is 1.23%. During the last decade, the gap between asset-weighted investor returns and total returns is 1.64%.

Karen Dolan is director of fund analysis with Morningstar.

You can think of this gap as the returns that were sacrificed because investors bought and sold funds at the wrong time. The pattern is clear: Investors tend to buy funds and asset classes following rallies and sell at low points, leaving a lot of money on the table in the process.

Over the years, we've examined investor behavior patterns in a number of ways. Some of our most conclusive findings show that investors have the hardest time using volatile funds well.

This time, we're taking a different angle. We've looked to see how Morningstar Investor Returns of funds sold through advisors compare with those of institutional and no-load shares as well as funds offered on retirement platforms. We also compared funds that charge 12b-1 fees with those that don't.

The expectation is that funds sold with the wrapper of advice should look better through the investor returns lens because the intermediary is in a good position to talk an otherwise emotional investor out of chasing returns or selling near the bottom. After all, that responsibility is often considered a key role for an advisor.

As it turned out, though, we couldn't prove or disprove that hypothesis. The results do not show a definitive pattern in either direction.

What Are Investor Returns and How Did We Slice Them?
Let's start with a brief overview of what we're measuring. Unlike the more frequently cited figure of total returns, which track the performance that would've been earned by an investor who bought at the start of a period and held all the way to the end, investor returns capture a truer picture of investor behavior. Investor returns are dollar-weighted and thus consider the timing of investor purchases and sales along the way. For example, a fund that posts a few chart-topping years with a small asset base subsequently attracts more money and then goes into a performance slump triggering redemptions would post meaningfully lower investor returns than total returns. 

The number we've focused on for this article is the gap between total returns and investor returns. That differential measures how much better or worse investors fared by moving in and out of funds than they would have with a buy-and-hold strategy. The bigger the gap, the worse investors' timing.

There's no exact way to track flows coming through advisors versus other channels, but we can approximate it by looking at share classes. We know that A , B, and C share funds are exclusively sold through advisors and brokers, so that's pretty straightforward. The picture gets a bit cloudy when trying to associate the purchases and sales of no-load share classes with one constituency. While it is true that a substantial proportion is sold directly to individual investors without advice, many independent advisors and other intermediaries funnel money into no-load shares, charging a fee for their service separately.

We looked at the data in one other way, too--funds that charge 12b-1 fees versus those that don't. 12b-1 is a fancy term for distribution. Often, 12b-1 fees cover the price investors pay for ongoing service from their advisors. They can also cover a portion of what it costs to be on a supermarket platform like Schwab and Fidelity. (The going rate to be on their no-transaction-fee platforms is 0.40%.) It is often the case that some distribution costs aren't labeled 12b-1 fees at all, but instead are lumped in with the management fee. Its clear that 12b-1 fees are far from a perfect way of isolating sales methods, but they are--in one way or another--used to sell and to fund practices that could theoretically exacerbate or prevent bad behavior.

The Results
One thing is clear: Across the board, investor returns are lower than total returns. Regardless of sales channel, the data don't provide evidence that advisors and institutions do an excellent job timing their moves while other channels are rife with fickle investors. In aggregate, they're all losing money to poor timing.



When rating the amount of damage among different channels, however, our findings are inconclusive. There is no clear indication that A, B, and C share funds sold through advisors/brokers have a noticeable leg up or disadvantage versus institutional or no-load shares when it comes to investor returns. While the advisor-sold group does seem to have an advantage if you look at the 15-year period, the difference is fairly small, and the same result doesn't hold over the 10-year period.


The data on 12b-1 fees are also inconclusive. Funds that charge 12b-1 fees seem to have invited better behavior during the 15-year period, but not during the past 10 years.

The Retirement class of funds does seem to have an advantage in both the 10-year and 15-year periods, but a note of caution is warranted.  The sample size was small because few retirement share classes existed 10 and 15 years ago. Looking forward, though, we wouldn't be surprised to see the pattern persist with investor returns in retirement shares coming closer to or even exceeding total returns.  Investors in retirement plans usually dollar-cost average into their retirement account with each pay check and the money tends to stay put.  If that pattern persists, it could mean that the laziness of retirement-plan investors has its advantages or those fund owners are better at resisting the temptation to chase performance.

Overall, however, these numbers don't make a clear case in favor of one side or the other. The data doesn't prove or disprove the premise that financial intermediaries and institutions are any more or less fickle than individual investors. The lack of conclusive evidence is perhaps the most striking takeaway.

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Karen Dolan, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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