Think you can guess the direction of the market? Surely any fool could have foreseen the market's collapse after Lehman Brothers failed in September 2008. And by March 2009, stocks were so cheap that they had nowhere to go but up.
Market timing seems so easy in hindsight. What's more, plenty of professionals -- including brokers, advisers and investment newsletters -- stand ready to offer you guidance on when to trim your exposure to stock funds and when to boost it.
But a groundbreaking study by Morningstar shows what a terrible price investors pay for market timing. During the past decade, the average investor's return trailed the average fund's return by 1.5 percentage points. And it came during a decade when the major market indexes sustained losses or produced paltry returns.
The study also indicated which companies' clients were most likely to lose money. More on that later.
Bad market timing, however, overwhelms skillful fund picking.
During the decade that ended Dec. 31, the average fund of all types, including stock funds and bond funds, returned an annualized 3.18%. But the average investor dollar earned an annualized 1.68%.
What are investor returns? They're simply what the average dollar invested in funds earns, as opposed to what the average fund returns.
Suppose a fund that holds $10 million in assets returns 20% in its first year. Investors, attracted by those boffo results, pour in money that swells the fund's size to $100 million at the start of the second year. But our imaginary fund gains just 2% in its second year. The fund is still up an annualized 10.6% for the two years. But hapless investors, most of whom came late to the party, gained only an annualized 1.83%.
Morningstar examined monthly cash flows in and out of mutual funds. Several other companies have made efforts to estimate investor returns, but Morningstar may be the first to dig deeply enough to produce findings that investors can deem trustworthy.
Volatility is the investor's enemy
As you might expect, the more volatile the fund, the more likely investors will badly time their buys and sells.Take Janus Twenty (JAVLX), a large-capitalization growth fund that boasts a terrific long-term record but comes with high volatility. Over the 10 years through June 30, the fund lost an annualized 2.9%. The average investor dollar, however, declined by an annualized 6.9%.
Investors in high-voltage funds -- concentrated in such sectors as technology, China or natural resources -- did worse.
By contrast, lower-risk Vanguard Wellington (VWELX), a balanced fund that holds about two-thirds of assets in stocks and one-third in bonds, returned an annualized 5.9% over the past decade. Wellington investors enjoyed an annualized 5.5% return, losing just four-tenths of a percentage point, annualized, to poor timing.
Indeed, investors in balanced funds generally surpassed the return of the average fund over the past 10 years. Investors in both U.S. stock and municipal bond funds, meanwhile, trailed average fund returns by an annualized 1.37% and 1.61%, respectively.
