Global MarketsSMSF Strategies

Investment lessons from the US

18 Oct 2021 1 month(s) ago

An annual study of US investment fund performance has some important takeaways.

Morningstar US has released its annual study of dollar-weighted returns (also known as investor returns. It finds investors earned about 7.7% per year on the average dollar they invested in mutual funds and ETFs (exchange traded funds) over the 10 years ended Dec. 31, 2020, which is about 1.7 percentage points less than the total returns their fund investments generated over the same period.

The pattern is no doubt similar in superannuation funds, where the actual returns generated by the fund was mismatched with the net return going to the clients. It is less of a problem with SMSGs, of course, because there are no fund managers drawing out their fees.

The Morningstar study found that the shortfall, or 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.”

Once again, the investment adage: ‘Don’t just do something, sit there,' is shown to have some truth in it. Simply aiming to capture the average return of the market is a way to get sound returns and avoid mistakes of timing (although it also lessens the possibility of big wins that might come from good timing).

Morningstar found US fund investors earned a healthy 7.7% investor return (which reflects the impact of cash inflows and outflows on the returns investors actually earn) over the 10 years ended Dec. 31, 2020, while their fund holdings generated a 9.4% annual total return over the same period. Thus, investors suffered a 1.7 percentage point annual return shortfall.

Some further points were made:

  1. U.S. equity funds and taxable-bond funds, had smaller return gaps than the fund universe as a whole.
  2. Investors in allocation funds, which combine stocks, bonds, and other asset classes, continued to show the smallest gap.
  3. Investors have struggled to use alternative funds successfully: The average dollar invested in these funds lost about 0.3% annually over the 10 years ended Dec. 31, 2020, which was more than 4 percentage points lower per year than the funds’ total returns and a remarkable 12 per centage points per year less than the dollar-weighted returns for investors in U.S. stock funds.
  4. Investors in sector equity funds also fared poorly, as their dollar-weighted returns lagged the funds’ reported total returns by about 4 percentage points per year over the 10 years ended Dec. 31, 2020.
  5. Specialized funds were doubly disappointing. Not only did their total returns lag those of diversified U.S. equity funds by a wide margin to begin with, but investors also failed to capture the full benefit of those lower returns.
  6. Investors in alternative, sector equity, and international-equity funds would have done significantly better by dollar-cost averaging, which involves investing the same dollar amount on a regular schedule.
  7. The more volatile a fund, the more trouble investors tended to have capturing its full return.
  8. The relationship between return gaps and fees was less clear-cut.

Amy Arnott, writing in FirstLinks, says the persistent gap between investors' actual results and reported total returns “may seem disheartening”, but investors can take away a few key lessons:

  1. Keep things simple and stick with plain-vanilla, broadly diversified funds.
  2. Automate routine tasks such as setting asset-allocation targets and periodically rebalancing.
  3. Avoid narrowly-focused funds for long-term investing, as well as those with higher volatility.
  4. Embrace techniques that put investment decisions on autopilot, such as dollar-cost averaging.

Arnott writes: “In particular, funds that offer built-in asset class diversification, such as balanced funds, help investors keep more of their returns. Investors' trading activity is often counterproductive. Investors can improve their results by setting an investment plan and sticking with it for the long term. Investors who follow a consistent investment approach and avoid chasing performance will likely reap rewards over time.”


Reader note: This is general reporting only and should not be considered in any way to be investment or tax advice. It does not take into consideration the investment objectives, financial situation or particular needs of any particular investor. For more information please read our disclosure statement.

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