Investors timing the market see biggest hit on sector funds

FOR investors, it’s important to remember there’s power in patience, even as markets churn.

An average investor loses out on as much as 2.6 per cent in annual gains by straying from a buy-and-hold strategy with certain US mutual funds and exchange-traded funds (ETFs), according to a new Morningstar report.

Wealth advisers have long cautioned against attempting to time the market. And investors who sell during periods of volatility often end up sitting in cash and missing out on market rebounds.

“If you get out when the market is down 10 per cent, it’s likely you won’t benefit from the bounce and the recovery,” said Rob Williams, managing director of financial planning at Charles Schwab. “Often you find that once you get back into the market it’s too late.” 

Morningstar’s annual “Mind the Gap” report measured total returns against how an average investor did when accounting for cash flows into and out of funds over a 10-year period ending Dec 31, 2023.

The largest gap between a fund’s total return and what the report calls the “investor return” was found in narrowly focused sector funds, which showed a negative 2.6 per cent gap annually. This means that while the average sector fund returned 9.6 per cent, the average investor saw a return of about 7 per cent. 

Sector funds focused on targeted industries like technology tend to be volatile. And that can lead to wider gaps on average, said Morningstar’s chief ratings officer Jeffrey Ptak.

“There is such a thing as a fund that’s too hot to handle, and we see that expressed in the study,” he said, adding that a takeaway from the report is that “keeping it simple pays off.”

Across all mutual funds and ETFs the average gap tends to be smaller at negative 1.1 per cent, with investors getting a 6.3 per cent return compared to a total return of 7.3 per cent. Still, that translates into investors missing out on about 15 per cent of a fund’s total return over 10 years.

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The lowest gap observed was in allocation funds, such as target-date funds that automatically rebalance, removing yet another opportunity to mistime a market move.

The Morningstar study, released on Aug 15, covered more than 20,000 fund share classes, representing nearly US$21 trillion in assets at the end of the study period. BLOOMBERG