Morningstar.com helpfully provides two types of performance data for mutual funds: total returns and investor returns. Total returns are what you usually see elsewhere, and assumes that one buys all at the beginning and holds the entire period given – the last 5 years, for example. Investor returns account for the timing of the buying and selling of investors on average. An example given is:
Assume a fund generated a 10% total return in a calendar year, with most of those gains coming in the year’s first quarter. If investors added substantial sums of money to the fund after its first-quarter runup, the fund’s investor returns for that year would be lower than the fund’s 10% total return.
Using this data, Morningstar can basically tell how the average investor was at market timing. Apparently, not so good. On average they sold too quickly after losses, and bought too late and missed part of the rebound. From the article Mind the Gap 2011:
In 2010, the average domestic fund earned a return of 18.7% compared with 16.7% for the average fund investor, making for a gap of 200 basis points. For the trailing three years, that gap was 128 basis points. For the past five years, it was 98 basis points, and for the past 10, it was 47 basis points.
For taxable bonds, the return gaps were 138 basis points for one year, 52 basis points for three years, 57 basis points for five years, and 106 basis points for 10 years. That 10-year figure is pretty large considering it meant that returns fell to 4.47% annualized from 5.53%. Municipal bonds have consistently had an even bigger gap ranging from 113 basis points last year to 173 annualized for the trailing 10 years.
To make it clear, those are huge performance gaps over time. Like saying goodbye to 25% of your nest egg huge. The data also found that people who owned balanced funds that owned both stocks and bonds did much better comparatively. This includes target-date style funds. That makes perfect sense to me, because the type of people who buy balanced funds are not the type to try to time the market.
They found similar results when comparing investors in Vanguard mutual funds that had both Investor and Admiral share classes. The more patient (and more wealthy) investors had better performance in 13 out of 15 cases, with a margin greater than the difference in expense ratios:
For example, in the firm’s flagship Total Stock Market fund, Admiral shareholders enjoyed returns of 6.16% annualized compared with 5.35% for Investor shares. At Vanguard Value Index, Admiral shareholders earned a 4.84% annualized return compared with 2.61% for Investor shares.
If you do try to time the market, you owe it to yourself to track your moves carefully (and honestly) to calculate if they were really better than doing nothing at all. Chances are, they weren’t. If you don’t do better after a certain time, say a couple years, it may be a good idea to stop while you’re not too far behind. Here are a couple of ways to find your personal rate of return that accounts for inflows and outflows.
- Estimate Your Portfolio’s Rate of Return (Calculator) – Even an estimate can be pretty helpful.
- Calculate Your Exact Portfolio Rate Of Return (Spreadsheet) – Wrote this a few years ago, but it’s still applicable.
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I am curious how other readers track their returns when you are constantly adding to your portfolio through out the year….I have played with xirr in excel some but I am curious how others have approached this.
From an article I wrote on this topic some time ago: “For the 20 years ended Dec. 31, 2006, the average stock fund investor earned a paltry 4.3 average annual compounded return compared to 11.8 percent for the Standard & Poor’s 500 index.”
This was from an analysis by a company named Dalbar which produces some very expensive reports containing such data.
Music to my ears. HOWEVER……..
I swear to you that I cannot defend the idea of passive investing to ANYONE within ear shot that doesn’t already believe so.
Anyone that trades will tell you they beat the market EVERY TIME!! Worst part is that I have no way to speak otherwise when I have no real data to argue with them on. Unless I actually SEE their statements, I’ll never know what they win/lose.
Even the TD Ameritrade guy (private CFP *via* TD) who, last year, got my father-in-law’s trust to handle, laughed at me when I told him I was a Boglehead and advised that he’d be happy to show me how he’s beat the market yearly for the last 20 years. It makes you doubt yourself until you see real numbers like this!!!
Thanks, Jonathan
@Sanders, I don’t exactly track my returns, but I do make a graph showing how much I would have with the contributions I’m making if I had achieved a consisted 8% return over time, how much I would have with 11% and how much I actually have.
Basically, since I make a contribution each month, I make a new cell in a spreadsheet for each month calculating the 8% or 11% growth from what I had the prior month and adding the contribution–or showing what my actual value is with the latest contribution. Then I make a graph from that sheet.
A big flaw with this method is that I do not compare this to actual returns in the sectors in which I am invested, so I don’t know how I compare to the market in general. However, since I have index funds, I’m not too worried about that.
Also, this doesn’t address the issue here which is what if I had invested a different way. I will occasionally make a graph for what the value of my investments would be if I had kept an old investment, but after a while, it gets out of date because it’s hard to keep up with what any dividend payments would have been.
@Sanders, yup, I use XIRR in Excel. I enter my (weekly) contributions, and I enter the value of the account on the 1st of every month. This lets me track the actual monthly, yearly, etc. return.
Here are a couple of ways to find your personal rate of return that accounts for inflows and outflows. Even an estimate can be pretty helpful.
Estimate Your Portfolio’s Rate of Return – Calculator
Calculate Your Exact 2006/2007 Portfolio Rate Of Return – Still applicable to current years
I believe E-trade actually computes performance of your stock and ETF holdings the same way a separate account manager would. In other words, you get a monthly performance number that takes into account inflows and outflows as part of the performance calculation. It has almost made me want to switch all my assets there as I can just buy the Vanguard ETFs I want… You can also set it up to track multiple portfolios, so I can see how my “active” component is doing compared to my “passive” component.
To the person whose CFP claimed to beat the market for the last 20 years I’d call B.S. If an institutional investor were able to do that for 20 years straight they would be on the cover of every investing magazine in the country. Hyperbole claims like that are technically illegal. Get him to say it in writing and you’d have something lovely to take to FINRA… I guarantee you he won’t put that claim in writing.
@Maury – I love the “put it in writing” idea. 🙂 Be prepared for incoming BS!
AFAIK Fidelity retirement accounts track this for your as well. For example my return so far YTD is 8.9%. I’m on my late twenties, so I regularly have fairly aggresive portfolio of 95% stocks.
That said, I’m happy I ‘parked’ my money on bonds since early May. I since just moved to 50% bonds 50% stocks