Morningstar Investor has been conducting annual surveys for ten years on how investors’ actual results stack up compared with the reported total returns of their mutual funds. Mind the Gap: A report on investor returns in the United States estimates the performance of the average dollar invested in mutual funds and exchange-traded funds and compares it to the funds’ time-weighted return. The difference, or “gap,” signifies the impact that the timing of investors’ purchases and sales had on the investment outcomes they achieved.
As of December 31, 2022, investors for the past ten years earned about 6% from their mutual funds and exchange-traded funds on an annual basis. This was about 1.7% less than the total returns of the investments in the funds.
Investors experience the gap because they enter and exit the market at the wrong times. They also switch from underperforming funds into outperforming funds and over the long run continue this trend instead of remaining invested and avoiding excessive trading.
“Investors in allocation funds, which combine stocks, bonds, and other asset classes, have continued to fare best, as these funds had the narrowest return gap of any category group” is one of the key takeaways from the study. Investors lost roughly one-fifth of their return by actively trading. This is the price paid for not simply buying and holding funds. Target-date funds and the TSP Lifecycle funds are examples of allocation funds.
How can you close the gap? Simply stay invested. Dips, bumps, and drops in the performance of funds are inevitable. Nothing is certain and that is part of the investment journey, but if you want to participate in the big returns of the market you have to be invested and not sit on the sidelines.
What is the Lesson for TSP Participants?
Members of the military and federal employees using the Thrift Savings Plan (TSP) to best save for their retirement should therefore remember to:
- Focus on funding your retirement plan, not the news headlines.
- Recognize the value of the diversity of the investments in the TSP funds.
- Know your risk capacity to create a personal allocation of the TSP funds and stick with it.
- Appreciate how the “too simple” inaction of the Lifecycle funds can work in your favor for the long run as an alternative if you are struggling with the task of a personal allocation blend of the five individual funds.
- Put your investment decision on autopilot by using dollar-cost averaging each pay period.
- Avoid the temptation of market timing by selecting scheduled times to review your portfolio and rebalancing; at least annually is preferable, and again when any major life events occur.
- Finally, simple beats complex, timing matters less than your holding period, and a good strategy you can stick with is vastly superior to a great one you can’t.
In 1996, Warren Buffet shared in his letter to Berkshire Hathaway Inc. investors, “We continue to make more money when snoring than when active.”
Warren Buffet’s average investment holding period is 7 years and he has held some investments for more than 20 years. Reuters reported in 2020 that the average investor’s holding period for stocks is less than 5.5 months.
Whenever the performance of your Thrift Savings Plan investments experiences volatility, consider looking at the funds’ long-term performance to enable you to get a good night’s sleep.
