Why Investor Returns Don’t Always Match Fund Performance

Even the best dogs* may be tempted to chase a squirrel in the park.

So may be the case with investors and returns. That’s part of the reason why returns for the average dollar invested in US mutual and exchange-traded funds reliably lag the returns of the products themselves. Over the past 10 years, the average dollar saw returns of 8.7% annually, compared with 9.9% across the universe of funds, which is an overall gap of 1.2 percentage points or 12% less, per Morningstar’s latest Mind the Gap report, published today. However, that difference may be shrinking, with the rolling 10-year average annual gap being about 1.7 percentage points in 2021 and 2022.

“Overall, I’m encouraged by what I’ve seen in the survey,” Morningstar managing director and report author Jeffrey Ptak said. “We’ve seen some improvements in the way fund investors access funds and the way they put them to work. By many measures, they’ve become more disciplined and less prone to the sort of self-injurious trading we’ve seen in the past.”

Delta Farce

Some categories stand out much more than others in terms of how the average dollar performed in comparison with average fund returns. The gap was lowest for US equity funds (0.4 percentage points) and highest for alternatives (1.6 percentage points), for example. There were also differences by management style, with the gap for active funds being higher than passive ones, at 1.6 percentage points versus 1.1 percentage points, respectively. 

While performance-chasing is responsible for much of the gaps, the timing of fund purchases from regular rebalancing or investing from every paycheck is also a contributor. Thus, the results aren’t “definitive proof of individual investors’ fallibility,” the report notes. Even so, the findings show the potential benefits in using simple, diversified funds, with allocation funds being particularly beneficial, Ptak said, adding that they automate mundane but important tasks like rebalancing and adjusting. “Simpler beats complex.”

For the first time, Morningstar also considered several other fund categories:

• Investors in buffer ETFs saw average returns higher than those of the funds themselves over three and five years, thanks to good timing of flows.
• Overall, there was only a small negative performance gap in the leveraged single-stock ETF category, but there were massive differences in how investors fared across individual funds.
• Crypto ETFs were a sore spot, with the average dollar losing 5.8% annually since January 2024, substantially less than the 8.5% average annual gain for funds in the category. 

Don’t Pull That Lever. Leveraged ETFs can be effective as extremely short-term trading tools, but they often don’t work well over time, said Chuck Failla, principal of Sovereign Financial Group. “The issue is that it’s falling into the hands of unsophisticated investors,” he said. “People should have access to more or less whatever they want, but they need to understand what they’re accessing. The issue with an ETF is that it’s so easy to access. It’s hard to put on any type of guardrail.”

*All dogs are good dogs, but we’re trying to make a point here, OK?