Bad timing can undermine good fund selection and substantially impact investor returns. To understand how much of a difference timing can make, and the factors that contribute to this discrepancy, we took a closer look at our investor-return data.
In Morningstar Research Services’ annual paper, Mind the Gap, we evaluated investor returns to identify how the average dollar in a fund fared over a certain time period. After this period was over, we could see how much poor timing affected the average investor. The chart below shows that the average investor lost 45 basis points to timing over five 10-year periods ended December 2018.
Source: Morningstar Direct and author’s calculations. Data as of 12/31/2018.
A second factor that could lead to higher investor returns is that low-cost funds attract savvier planners and individual investors who make better use of their funds.
The chart also shows that investor returns are higher for cheaper funds and that the gap grows as funds increase in cost. This means that high-cost funds tend to create bad timing and lower returns, therefore emphasizing why cost should play a large role in fund selection.
Does volatility impact investors’ timing?
In addition to the difference in returns, we assessed the reasons investors made timing errors and how they fared when we grouped investments by expense ratio and volatility. When we broke down funds within asset classes based on their standard deviation, our research revealed a consistent story. The chart below shows that funds in the least-volatile quintiles consistently had higher investor returns than those in more-volatile quintiles. (Though we sorted funds by Morningstar Category for other factors, we sorted within asset classes for this one because volatility differences within categories tend to be small.) These findings suggest that “boring” funds work well because they aren’t as likely to inspire fear or greed. Also, timing simply has less impact on investor returns when a fund has lower standard deviation.A look at how fees impact investor returns
Fees also provide a clear understanding of the gap in investment performance. As depicted in the chart below, low-cost funds tend to lead to higher total returns and higher investor returns. Costs can be good predictors of performance, so this makes intuitive sense.
Source: Morningstar Direct and author’s calculations. Data as of 12/31/2018.
A second factor that could lead to higher investor returns is that low-cost funds attract savvier planners and individual investors who make better use of their funds.
The chart also shows that investor returns are higher for cheaper funds and that the gap grows as funds increase in cost. This means that high-cost funds tend to create bad timing and lower returns, therefore emphasizing why cost should play a large role in fund selection. 
