TDFs Have Helped Close the Investment Return Gap

Because of poor timing in purchasing and redeeming funds, investors tend to earn less than what the fund returns, Morningstar notes in a white paper “Mind the Gap 2018.”

“Investors large and small tend to sell after downturns only to buy back after a rally,” the research firm says. “But remaining invested in target-date funds [TDFs] and benevolent market conditions have narrowed that gap.”

For instance, the typical investor in diversified domestic equity funds earned an 8.32% annualized return for the 10 years ended March 31. By comparison, the average diversified domestic equity delivered an average 8.93% return, making for a shortfall of 0.61 percentage points.

Balanced funds, which include TDFs, saw a positive gap of 0.30 percentage points, with the average investors enjoying a 5.93% annualized return. The gap for municipal bond funds shrank slightly to a 1.26-percentage point annualized shortfall based on investor returns of 2.23%.

In other classes, the gap worsened. The gap between international equity funds grew to 105 basis points (bps), with total investor returns of 2.95%. The gap in taxable bond funds grew to 87 basis points with an annualized investor return of 3.01%.

Alternatives show the worst investor returns but the best investor-returns gap. The investor return is a dismal 9 basis points for the 10 years, but the gap is a positive 140 basis points.

In the aggregate, the average investor trailed the average fund by 26 basis points annualized over the past 10 years; the investor return for the period was 5.53% a year compared to 5.79% for the average fund.

The five-year investor return gap figures are significantly better than the 10-year numbers, with one notable exception: Alternative funds saw their gap flip into negative territory with a 46-basis-point gap on investor returns of 1.21% a year.

“Target-date funds have proved remarkably consistent at producing good results for investors,” Morningstar says. “[When] investors commit to consistent investment regimes, investor returns are strong and the gaps are often positive. We think that the tremendous diversification of target-date funds, combined with the steady investment of 401(k) plans, shows the fund industry at its best.”

The “Mind the Gap 2018” white paper can be downloaded here.