Bonnie Bauman

Morningstar Study: Short-term Buying and Selling Equals Lower Returns

Short-term buying and selling takes a bite out of investors' returns, so says a recent Morningstar Inc. study.

The study showed that returns earned by fund investors were worse than funds' official or advertised returns. The difference had to do with the length of time shareholders held onto their fund shares and the timing of their purchases and sales, the study reports.

"Investors frequently make the mistake of thinking that the recent past will repeat itself. As a result, they buy too late and sell too soon," writes Russel Kinnel, editor of Morningstar FundInvestor, a monthly newsletter for investors, which published the study.

Specifically, Morningstar analysts looked at returns for all U.S. stock funds with 10-year records, then calculated the gap between funds' official returns and the returns earned by the funds' typical shareholders. (The latter was calculated by dollar weighting the returns. That's because dollar-weighted returns are a more accurate reflection of investors' actual returns because they account for how funds performed based on their level of assets.)

Among diversified categories, the gaps were largest among growth funds, the study showed. For instance, the 10-year annualized dollar-weighted return for the average large-growth fund was 3.4 percentage points lower than the stated return. For mid-growth funds, the gap was 2.5 percentage points, and for small growth funds it was at 3 percentage points.

Sector funds saw the widest gaps. For example, the dollar-weighted returns of tech funds lagged official returns by an average of 14 percentage points. The sizable gap is due to shareholders scrambling to invest their dollars in growth and technology funds in late 1999 and 2000, and then cashing out their shares after the tech bubble burst a few years later.

The wide gaps reflect the inclination of shareholders to buy into a fund when it's the most in demand and drop it after it falls from favor.

In the meantime, large value funds reflected the smallest gaps at 0.4 percentage point. That's because those funds were less volatile and posted more steady returns. It seemed shareholders were more apt to stick with a fund that posted more stable returns.