Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 125

Timing badly: generating poor returns in good strategies

In the 1987 film Wall Street, Gordon Gekko is challenged by his prodigy, Bud Fox, on how much money is enough. Gekko responds that it’s not a question of enough - it's a zero sum game. Money itself isn't lost or made, it's simply transferred. Somebody wins, somebody loses.

Significant new research soon to be published in the Journal of Portfolio Management* reveals a win lose dynamic in mutual fund investing (what we call ‘managed funds’ in Australia). The key finding is the average United States mutual fund retail investor underperforms the fund they invest in by about 2% a year. While the fund’s investment strategy may be sound and generating outperformance against a benchmark, investors’ poor timing of when they buy in and sell out effectively transfers elsewhere the value premium created by the fund.

In reaching this finding the researchers analysed over 1 million fund flow observations across 18,665 funds between 1991 and 2013. The dollar-weighted average of investors’ returns within a fund was compared to the buy and hold return for the whole fund.

As the researchers explain:

“The average return from a buy and hold implementation ignores the fact that many investors trade on a regular basis and that the actual return received by the average investor might be very different from the buy-and-hold return. Dollar weighted returns account for this trading by augmenting the average with information about fund flows.”

The pattern of average investors’ underperformance against overall fund performance was consistent across funds irrespective of varying investment styles – value, growth, large and small cap, as shown below:

The less sophisticated are worst at timing

Investors mistiming the market are underperforming by an average 1.3% to 3.1%, with worse investor underperformance seen in growth compared to value funds, and in large cap compared to small cap funds. For example, fund investors seem to time poorly by investing in value funds when the ‘value’ factor is expensive, and redeeming from value funds when ‘value’ offers opportunities. Poor timing is not confined to value funds, and confirms other studies which show investors attempt to time their allocations to funds.

The research reveals what is happening, but it isn’t possible to definitively conclude from the data why investors time poorly, and nor was this a stated purpose of the research. What is especially interesting is that it examines the actual investment outcome for mutual fund investors, not the performance of mutual fund managers.

The data leads to an hypothesis that investors who time poorly are less financially sophisticated. This is deduced from more detailed multivariate analysis revealing the worst average returns were seen by investors who hold funds with higher expense ratios, and who invest in readily available retail-oriented mutual funds. Investors in these funds were observed as more likely to time poorly, buying after and selling before periods of strong performance.

Their poor timing may be unintended – for example investors may withdraw to meet unexpected financial needs. It may be related to low financial literacy. They don’t understand their investment timeframe isn’t suited to the fund’s recommended timeframe. Or it may be from overestimating their investing prowess. They are consciously trying to time outperformance or chasing previous hot performance by the fund. Whatever the reason, they have timed poorly and are Gekko’s losers. In fact, the authors subtitle their paper, “A Guide to Generating Poor Returns While Investing in Successful Strategies.”

Value premium is transferred to the winners

So who are the winners on the other side of the trade? The research is based on United States data where mutual funds account for nearly 20% of the equity market. The authors suggest institutional investors are most likely to be capturing the return premium from retail fund investors: smarter traders adhering to more considered strategies. By giving away the excess return, retail investors in value funds might themselves be financing the value premium often seen in fund performance, and ensuring its continuance.

What might be done about it? After all, retail mutual fund Product Disclosure Statements are filled with recommended investment timeframes, likelihoods of negative returns over given time periods, explanations of different investment risks, statements that past performance is no indication of future performance and the importance of time in the market as distinct from timing. What is missing that will grab investors’ attention and help them avoid poor timing?

Investors may reconsider their own behaviour if presented with the hard real dollar impacts of poor timing experienced by others. Perhaps fund providers could undertake similar analysis on observations within their own funds and present key findings to investors and financial advisers (assuming of course empirically the same pattern holds). It points to a need for greater financial education to protect investors from themselves.

Without behaviour change poor timing will continue and many investors will miss the returns their mutual funds generate. They lose and somebody else wins.

 

*Jason Hsu, Brett Myers, Ryan Whitby, “Timing Poorly: A Guide to Generating Poor Returns While Investing in Successful Strategies”, Journal of Portfolio Management (forthcoming Winter 2016).

 

Iain Middlemiss was Executive Manager Strategy at Colonial First State and Head of Strategy at Superpartners. This article is for general educational purposes only.

 

5 Comments
Michael
September 24, 2015

If I may, I would really like to see a physical example of this...that is, let's say I bought xyzabc fund when it's unit price was relatively high, but, I am a long term investor and do not need the money immediately. Will it follow that in the long term xyzabc will return a positive ?

Paul G
September 04, 2015

Of all the value adding activities of a Financial Planner probably the most value is added for clients by convincing them to stay the course during market falls and not overexposing themselves to growth assets when times are good.
That is, to ensure their asset allocation is correct considering their personal objectives.
see Brinson, Hood & Beebower determinants of market performance.

Anthony Robinson
September 04, 2015

Why bother with fund managers just pick well performing (over 10yrs) listed investment companies. Much better than fund managers! They don't have to sell the position if the fund drops or invest if funds flow into the fund.

Jerome Lander
September 03, 2015

Very simply, most investors, unfortunately, simply invest in something after it has had a good run, and is more likely to be overpriced and at risk of mean reversion. In other words they chase past performance for behavioural and psychological reasons. It is really that simple. They don't understand things from first principals.

Investors would be better off understanding that everything ebbs and flows. They should make sure that they are actually exposed to something good in the first place, and then generally stick with it subject to it being aligned with their objectives.

The problem currently is that most people are not exposed to something good or in any way genuinely value adding..., in an environment where they may be completely destroyed by such an approach. They have been taught that cheap is good, and that not doing due diligence and trusting the overall market will get them where they need to go. Such an approach is generally very dangerous and relies predominantly if not purely on luck, particularly given the potential scenarios that exist today. It is a critical and common mistake based on a misunderstanding of reality.

Of course, investors would be better off by investing alongside people with genuine expertise who use the foolishness and ignorance of the market at large as profit making opportunities, and who are able to genuinely add value through time.

Adam
September 03, 2015

But who knows what they invested in for the periods they were not invested in the mutual fund? If you read it quickly a reader would interpret this as “the average mutual fund investor underperforms by nearly 2% a year” which is different to what is actually written.

 

Leave a Comment:

RELATED ARTICLES

My disinterest in investments as an investment specialist

The pros and cons of short-term versus long-term investing

Investing like Jerome Powell or the Future Fund

banner

Most viewed in recent weeks

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 605 with weekend update

Trump's tariffs and China's retaliatory strike have sent the Nasdaq into a bear market with the S&P 500 not far behind. What are the implications for the economy and markets, and what should investors do now? 

  • 3 April 2025

Designing a life, with money to spare

Are you living your life by default or by design? It strikes me that many people are doing the former and living according to others’ expectations of them, leading to poor choices including with their finances.

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Latest Updates

Investment strategies

An enlightened dividend path

While many chase high yields, true investment power lies in companies that steadily grow dividends. This strategy, rooted in patience and discipline, quietly compounds wealth and anchors investors through market turbulence.

Investment strategies

Don't let Trump derail your wealth creation plans

If you want to build wealth over the long-term, trying to guess the stock market's next move is generally a bad idea. In a month where this might be more tempting than ever, here is what you should focus on instead.

Economics

Pros and cons of Labor's home batteries scheme

Labor has announced a $2.3 billion Cheaper Home Batteries Program, aimed at slashing the cost of home batteries. The goal is to turbocharge battery uptake, though practical difficulties may prevent that happening.

Investment strategies

Will China's EV boom end in tears?

China's EV dominance is reshaping global auto markets - but with soaring tariffs, overcapacity, and rising scrutiny, the industry’s meteoric rise may face a turbulent road ahead. Can China maintain its lead - or will it stall?

Investment strategies

REITs: a haven in a Trumpian world?

Equity markets have been lashed by Trump's tariff policies, yet REITs have outperformed. Not only are they largely unaffected by tariffs, but they offer a unique combination of growth, sound fundamentals, and value.

Shares

Why Europe is back on the global investor map

European equities are surging ahead of the U.S this year, driven by strong earnings, undervaluation, and fiscal stimulus. With quality founder-led firms and a strengthening Euro, Europe may be the next global investment hotspot.

Chalmers' disingenuous budget claims

The Treasurer often touts a $207 billion improvement in Australia's financial position. A deeper look at the numbers reveals something less impressive, caused far more by commodity price surprises than policy.

Fixed interest

Duration: Friend or foe in a defensive allocation?

Duration is back. After years in the doghouse, shifting markets and higher yields are restoring its role as a reliable diversifier and income source - offering defensive strength in today’s uncertain environment.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.