This pattern extends to the stock, bond, and money markets.
The chart below shows investor net new fund flows into stock mutual funds versus world equity total returns over the 2000 – 2013 period. As you can see, investor fund flows tend to track market returns. This results in investors buying stocks at higher prices and selling stocks at lower prices and is one factor in investor returns trailing fund returns.
Performance chasing in stocks
One likely culprit in the equity returns gap is performance chasing, as investors buy and sell funds based on past performance . A recent Vanguard study, Quantifying the Impact of Chasing Performance, reports return gaps from investor turnover of funds (three years is the average investor holding period). Investors tend to move in and out of styles (growth vs. value and large vs. small) after a style has outperformed.
Performance gap across U.S. stock styles
Investor fund flows into and out of bond funds tends to follow the trend of bond fund total returns. In this instance, investors tend to buy bond funds when interest rates are falling (as fund net asset values rise) . Investors tend to sell bond funds when interest rates are rising (as fund net asset values fall). This results in investors buying bonds at higher prices and selling bonds at lower prices. Once again, this is a factor in reducing investor returns relative to fund returns.
Investor flows into and out of money market funds tends to track the relative differential between money fund interest rates and the rates available on bank money market accounts and bank CDs. Investors tend to shift to the higher yielding account. Investors can increase interest returns on cash balances by using the higher interest return on comparable cash instruments. (Keep in mind that treasury bills and FDIC insured cash instruments have very low credit risk).
Morningstar reports the return gap between investor asset weighted returns and fund total returns over the ten year period ending in 2013.
Reducing fund gaps
One can attain most of the returns provided by investment markets by investing in a low-cost balanced portfolio allocation that is bought, held, and rebalanced according to a set plan. This strategic decision can help eliminate:
- The tendency to buy and sell investments according to current news, or current market predictions.
- Avoid being overly enthused and investing too much into an asset class during market advances or being overly depressed and investing too little in an asset class during market declines.