“Buy and hold” and “don’t time the market” may be some of the most famous pieces of advice in the investing world, but this common wisdom falls on deaf ears. Want proof? In 2020, panicked investors pulled out half a trillion dollars as the pandemic sent markets into a tailspin, but when stocks rebounded, many missed out on the gains.
This is according to a new Morningstar report. I notice The Gap Report is an annual analysis of the so-called investor return gap, or the difference between the returns investors actually earned and the total returns reported for various funds. Morningstar estimates that the average investor earned 6.3% annually from 2013 to 2023, a full percentage point below the 7.3% average total return for U.S. mutual funds and ETFs. This gap can be largely explained by investors’ poor market timing.
That 1.1% difference—Morningstar approximates actual returns at 6.25% and 7.33% per year—may not seem like much, but it adds up. Morningstar estimates that the average investor lost about 15% of total returns over the 10-year period.
That difference comes into play because the reported 7.3% return assumes that investors stayed invested the entire time period. But that’s not how most people actually invest, Morningstar points out. They might make an initial purchase midway through the year, for example, or withdraw the money at any time.
“The return you get is not going to be the same as the buy-and-hold return,” says Jeffrey Ptak, chief ratings officer at Morningstar. “It’s going to be whatever the average dollar amount you make, given the timing and amount of those buys and sells. If you buy high and sell low, your return will lag the buy-and-hold return.”
As it turns out, investors are more likely to do exactly what they’ve been repeatedly advised not to do — sell when the market is down and miss out on the subsequent rally. While there was a gap between investor returns and total fund returns for all 10 years the study analyzed, 2020 was particularly bad, according to the research. There was a negative 2% gap that year, thanks to wild volatility and uncertainty that sent regular investors scrambling. Investors pulled their money throughout the spring when the market was in a downturn, only reallocating it after the market began to recover.
The report stresses the importance of investors staying calm and continuing to work throughout market volatility. Even regular trading inevitably leads to deep sadness, says Burt Malkiel, author of the best-selling book Investing. Random Tour of Wall StreetIt was said before luck.
“There’s clear evidence by looking at individual investors that those who traded the most are the ones who lost the most money,” said Malkiel, now chief investment officer at Wealthfront. “Nobody can time the market, so don’t try to. If you do, you’re more likely to get it wrong than right.”
Additionally, this explains why many experts like Malkiel encourage investors to choose low-cost, broad-based index funds rather than trying to pick the best individual stocks or sectors. These funds performed the best among the funds Morningstar looked at, with the lowest gap in investor return.
Meanwhile, sector equity funds had the largest gap, lagging investor returns by about 2.6 percentage points. Passive funds also significantly outperformed active funds.
“The results suggest that routine investing, such as making regular contributions to a retirement plan, can itself be beneficial in generating higher returns,” Morningstar’s Ptak wrote. “The more investors can automate saving and investing, the less likely they are to engage in costly trading activities. In that sense, it’s like adding and subtracting.”