Fund investors hurt themselves through poor timing

| Monday, Feb. 25, 2013, 12:01 a.m.

BOSTON — The recipe for successful investing sounds pretty simple: have reasonably good timing over the long haul and avoid big mistakes. That's what helps professionals build a worthy track record. For average investors, it's advisable to set the bar lower. Construct a balanced portfolio of low-cost mutual funds, make regular contributions to invested savings, and stick with it until it's time to retire.

The problem is that many investors seem to think they're better than that and can beat the stock market. Yet, research consistently shows that it's a fool's game.

The latest findings are from Morningstar Inc., which compared the performance numbers that mutual funds posted with the returns that the investors in those funds actually obtained over multiple years. It's typical to see gaps between the figures. That's because investors move cash in and out as markets rise and fall, and consequently don't experience the same results as the funds they invest in.

Funds posted an average annualized return of 7.1 percent over the past 10 years, through the end of 2012, Morningstar found. But the returns that investors actually realized were a full percentage point lower: 6.1 percent. Those totals factor in all stock funds and bond funds that Morningstar tracks, as well as both individual investors and institutional shareholders.

If the percentage point gap between the figures seems modest, you may be underestimating the impact of compound interest. Small differences really add up over time.

Gaps between fund returns and what Morningstar calls “investor returns” can vary widely, but the investors almost always underperform. Over the past 5 years, funds posted an average annualized return of 2.0 percent to 1.5 percent for their investors. Over 3 years, the gap was smaller: 7.6 percent for funds to 7.4 for investors.

The findings confirm that fund shareholders are often their own worst enemies.

“When people don't hold on to funds for long, you're generally going to have a bad result,” says Russel Kinnel, Morningstar's director of fund research.

Fear and greed often take over, particularly when stocks are veering wildly up and down. Many investors latch on to a hot stock or fund too late and miss most or all the upside. When the market declines, they bail out and don't participate in the eventual rebound.

With stock prices near five-year highs, it's instructive to consider lessons learned a dozen years ago. When technology stocks and Internet funds surged in the late 1990s, investors piled in. But many got in too late, and reeled when the tech bubble burst.

There are examples of funds whose investors have outperformed the funds themselves. That occurs when a shareholder invested in the fund when it delivered its strongest returns, and didn't keep cash in the fund when it was underperforming. But those instances are comparatively rare.

“The better you know yourself — what you're good at, and when you get emotional — the better you're likely to do as an investor,” Kinnel says.

If you know you're prone to making rash short-term moves, it can be worthwhile to check how a fund's posted returns differed from the results investors experienced. If there was a sizable gap, it means the fund's investors have, on the whole, had poor timing. That could increase the chance that you won't fare well either.

Be careful, however, in reading too much into a fund's gap over just a few years. Says Kinnel: ‘There can be quirks, so it's important to look at the big picture.”

Mark Jewell is a personal finance writer for The Associated Press.

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