We estimate the average dollar invested in US mutual funds and exchange-traded funds earned 7.0% per year over the decade ended Dec. 31, 2024. That estimate, which is akin to an internal rate of return calculation, accounts for investors’ purchases and sales of fund shares during that 10-year period.
The 7.0% annual dollar-weighted return is about 1.2 percentage points per year less than these funds’ 8.2% aggregate annual total return (which assumes an initial lump-sum purchase) over the 10 years ended Dec. 31, 2024. That “gap” is explained by the timing and magnitude of investors’ transactions during the period.
Exhibit 1: Annual Investor Returns and Total Returns of US Open-End Funds and ETFs (10 Years Through Dec. 31, 2024)
This is among the key findings from our annual “Mind the Gap” study. You can find the full report here, but in case you don’t have time to read the whole thing, here are five key takeaways from the study and the lesson each imparts.
The Gap Isn’t Going Away
The 1.2-percentage-point per year gap, which is equivalent to around 15% of funds’ aggregate total return over this period, is more or less in line with gaps we estimated over the 10-year periods ended Dec. 31 of 2020, 2021, 2022, and 2023. In other words, it’s been persistent.
Exhibit 2: Rolling 10-Year Annual Investor Return Gaps
Investor Lesson: There can be debate about what causes investor return gaps—some chalk it up to behavior, but it appears to reflect a number of factors, including the context in which investors utilize funds. Whatever the cause, it seems to be a rather persistent cost, not unlike fund expense ratios. But just as investors have learned to shop around for the cheapest funds, investors who are deliberate about the necessity, timing, and nature of transactions can ensure they capture as much of their funds’ returns as possible.
All-in-One > Building Block
In absolute terms, investors in sector equity funds saw the largest shortfall to the funds’ total return, as the average dollar gained 7.0% per year compared with the funds’ aggregate 8.5% annual total return.
Investors in allocation funds captured the largest share of their funds’ aggregate total returns, with the funds’ 6.3% per year dollar-weighted return accounting for nearly 97% of the funds’ 6.5% aggregate annual total return.
Exhibit 3: Annual Investor Return Gaps by Category Group (10 Years Ended Dec. 31, 2024)
Investor Lesson: Investors have had more success capturing the total returns of all-in-one funds, like target-date funds. Conversely, they’ve struggled with specialized funds like sector equity funds that are likelier to be used in a stand-alone or nonstrategic way. This argues to hold fewer, widely diversified funds that automate routine tasks like asset allocation and rebalancing, obviating the need for investors to take action.
The More Investors Traded, the Less They Made
Funds with more-volatile cash flows (which proxies for investor trading activity) tended to earn lower dollar-weighted returns than funds with more-stable cash flows. The return of the average dollar invested in funds with the most stable cash flows, that is, the least trading activity, lagged the funds’ aggregate total return by 0.8% per year, which was 1-percentage-point narrower than the gap for funds with the most volatile cash flows.
Exhibit 4: Annual Investor Return Gaps by Cash Flow Volatility Quintile (10 Years Ended Dec. 31, 2024)
Investor Lesson: The more investors traded, the less their average dollar made when compared with the funds’ aggregate total returns. This underscores the importance of holding the line on transacting, which can be accomplished by keeping discretionary trades to a minimum and automating other routine tasks, like rebalancing, to the greatest extent possible.
‘Different’ Didn’t Translate to Success
The more funds’ returns diverged from their style-appropriate benchmark (“tracking error”), the wider the gap between their investor and total returns tended to be. The average dollar invested in funds with the lowest tracking error lagged the funds’ aggregate total return by less than 1 percentage point per year versus nearly twice that for funds with the highest tracking error. Funds earned similar aggregate total returns, but investor returns gradually eroded as you moved across the tracking-error quintiles.
Exhibit 5: Annual Investor Return Gaps by Tracking Error Quintile (10 Years Ended Dec. 31, 2024)
Investor Lesson: While there can be merit to active funds that go their own way, one potential trade-off investors face is the degree to which they can capture the funds’ total returns. These higher-tracking-error funds’ more idiosyncratic approaches can test resolve, leading to mistimed purchases and sales, which could explain their wider investor return gaps. It’s worth noting that this pattern was more pronounced among US equity and taxable-bond funds.
Volatility Crossed-Up Investors (Again)
The more volatile funds were, the more trouble investors had in capturing the funds’ aggregate total returns, as evidenced by much larger investor-return gaps among the most volatile quintile of funds.
Exhibit 6: Annual Investor Return Gaps by Standard Deviation Quintile (10 Years Ended Dec. 31, 2024)
Investor Lesson: More-volatile funds appear likelier to push investors’ buttons, potentially leading to mistimed purchases and sales that dent dollar-weighted returns. While that alone isn’t a reason to eschew more-volatile strategies, it argues for caution, as wide return fluctuations could induce performance chasing or rattle investors into selling amid a sharp drawdown.
Switched On
Here are other things I’m reading, listening to, or watching:
- The Odd Lots podcast on how the Bureau of Labor Statistics assembles the monthly nonfarm payroll report (and why revisions go with the territory)
- Sound Opinions podcast does a classic-album deep-dive into OutKast’s Stankonia
- Tame Impala “Let It Happen (Soulwax Remix)”
Don’t Be a Stranger
I love hearing from you. Have some feedback? An angle for an article? Email me at jeffrey.ptak@morningstar.com. If you’re so inclined, you can also follow me on Twitter/X at @syouth1, and I do some odds-and-ends writing on a Substack called Basis Pointing.
