The Smart Take:
Surprise! Another robust study showed investors are still underperforming and making bad investment decisions. Morningstar released its yearly “Mind the Gap” study last month, showing investors have lost on average 1.7% yearly — that’s $17,000 on a $1,000,000 portfolio — over the last decade. Why so and how can we stop the madness?!
In this episode hear Tyler Emrick, CFA®, CFP® break down the study’s results and describe how True Wealth helps families not make the same mistakes as the average investor.
Click to read Morningstar’s Mind the Gap study: https://www.morningstar.com/lp/mind-the-gap
Here are some of the things we will discuss in this episode:
- Background on the ‘Mind the Gap’ study from Morningstar.
- The study found a 1.7% gap from average investor to the average fund return.
- Timing the market costs investors regular and the data from the last four years shows that.
- There’s always a new reason to give us the belief that we can time the market.
- The illusion of control bias can lead people to believe they have more control over the outcome than they actually do.
Sign up for our newsletter on our podcast page: https://www.truewealthdesign.com/podcast/
Need help making sure your investments and retirement plan are on track? Click to schedule a free 15-minute call with one of True Wealth’s CFP® Professionals.
Click the below links to subscribe to the podcast with your favorite service. If you don’t see your podcast listed with your favorite service, then let us know, and we’ll add it!
Today on Retire Smarter, surprise, another study came out showing investors are still underperforming and making bad investment decisions. Morningstar released its yearly Mind the Gap study last month and to no surprise, investors are still making the same mistakes. How can we stop the madness? In this episode, I’ll break down the study’s results and how True Wealth is helping families not make the same mistake as the average investor, coming up today on Retire Smarter.
Hey, it’s another edition of True Wealth Designs Retire Smarter. Welcome, I’m Walter Storholt alongside Tyler Emrick today. Tyler is a chartered financial analyst and a Certified Financial Planner. And as he teased you at the beginning of the show today, it’s not good news for investors as we look back at what happened in 2022.
Looking forward to discussing this study with you, Tyler, I think we’ve done this with maybe you or Kevin last year. We looked at the 2021 data, I want to say. So it’d be good to kind of see what’s still happening in 2022 and take some lessons from the ups and downs of the market. And it sounds like it was a lot of downs for those who were in that practice of timing things.
That’s right. Well, got a good show for us today and excited to be here. Had a good weekend. How about yourself?
Yeah, it was a great weekend. Did a little hiking and took a few good photos. Had an elk right on the trail, Tyler, so that was kind of cool. Very serene and-
You say cool, I say maybe a little scary.
Maybe a little bit, yeah. The elk was very chill, so it wasn’t like some of the elk that you see. Right now is rut season, so the male elk are creating their harem. We could go and do a whole podcast about that. We were watching them bugle and kind of do their thing out in the meadows last night, which was very educational and interesting.
So the bull elk are very aggressive. This was just a cow, I think, in the trail by itself, eating, having a good time. So she was very docile and didn’t mind having her photo taken. So I gave the respectful distance but then snapped off a few good shots, so that was great.
So nothing too scary, huh?
Yeah, nothing too bad.
We should tell the audience you have a new microphone, my friend. Well, congratulations.
I do. Yeah, we’ll see how I sound. We’re moving on up. I’ve got this big bulky thing in front of me. Looks pretty cool sitting on the desk, so hopefully I sound great.
This one has lights on it, doesn’t it?
It does a little bit. It does. It’s lightened up. It’s very official. It’s very, very official. But hey, Walt, I got to ask, have the leaves started changing yet? We’re getting some falling, okay.
Just a little bit. So there’s some orange and yellow starting to dot up in the mountains a little bit. So yeah, it’s kind of in that cool stage where you’ll see a tree and it’s still all green except one branch has turned and it’s like, “Oh, what made that branch special? Why did that one turn early?” And so, that’s kind of cool to see. The reds have seemed to come out early this year. There’s a few trees that have just gone red in an instant, so that’s kind of cool. But I think we’re still probably a week to maybe two out from things really starting to explode.
Be here before you know it. It was a little chilly here in northeast Ohio over the weekend. Good, a good little chilly. But fall is rapidly approaching or might be already here.
Very quickly. It was 36 when I started my hike the other day, so it felt like it had arrived in a big way that morning. But I guess you expect that if you’re up at 10,000 feet, so-
Yes. Oh, absolutely.
… not too much of a surprise. Well, let’s dive into this study, Tyler, and not keep the folks waiting especially if we have any market timers listening into the show today. I’m sure they’ll be extra interested in what this study says and your take on these things.
We’ll give them a little bit of data for sure. So Morningstar actually has their annual studies. For those not familiar Morningstar’s, a very large investment research and financial services firm, very well known in the industry. If you’ve done any type of research or Internet searches, I’m sure you’ve come across them. And the annual study is called Mind the Gap Study and essentially what it does is the study estimates the return of the average dollar invested in funds and exchange traded funds, i.e. investor return.
And it compares it with the average funds total return with any difference between the two attributable to timing of the investors’ purchases or sales. So in short, it’s basically saying, “Hey, what has been the effect of individuals jumping in and out of investments and has it hurt them or helped them in the long run?” And the study is really a rolling 10-year period so it gets updated yearly. So what we’re taking a look at is the data, as you alluded to, Walt, from December 31st of 2022.
And if we look back, they always do it based off of an average annual return. So over that 10-year period or that running 10-year period, the average fund gained a little under 8% return per year during that time period. And the gap between the fund’s performance and individual’s performance was a little below 2%. It sat right at 1.7% difference. So let me do some quick math for us here. If we’ve got a million dollar portfolio, individual investors, we’re down about $17,000 below the actual fund performance.
Not a small chunk of change.
No. And thank you for doing the math and not making me do that.
Absolutely. And we got to remember that’s average annual return, so that’s 17k a year on a million dollar portfolio that the average investor is giving up by timing the market. So what is that like, one fifth of the fund’s performance? It’s a pretty significant shortfall and frankly it’s not a new phenomenon, which is really what kind of drives me a little bit crazy. If we go back to the same data, the same report over the years, it really hasn’t changed much.
And frankly it’s gone up. Back in 2018, the results, the gap was a little over 1.5% and now we’re getting closer to 2%. So over the last few years we’ve continually seen investors underperforming just the funds themselves to where if they would’ve just bought and held, they would have gained that roughly 17k a year that I mentioned before, which is again just a pretty wild stat.
And so we felt, “Well hey, why don’t we take some time, we’ll dive into it.” And obviously it’s something to where I feel like there’s a lot of data out there, Walt. Wouldn’t you say that’s probably the biggest no-no, that you hear as you’ve gone through your podcast or done your research? “Hey, don’t try to time the market.”
Absolutely. I would say if there’s one mantra that has been pumped up over time, it would be that one, “Don’t time the market. It is a fool’s errand.” Even the best can’t do it. Those are all kinds of the terminology and the phrases I’ve heard surrounding that.
Sure. I think’s very maybe even interesting about it and it’s like, “Well, why do we keep making the same mistakes?” And even looking back on last year, if you do any type of reading on the economy or listen to the news throughout 2022, I think most economists and news channels were all saying, “Hey, recession’s coming, recession’s coming. 2023 is going to be a rough go.” And then I think families are looking at their local banks and the CD rates and savings accounts getting close to 5% and it’s like the shiny new object, right?
“Hey, why do I want to take on that risk? I’m going to pull my money out and I’ll go to cash. I can get that 5% on a CD.” And too, again, all the headlines, all the negative news articles saying how the economy is coming up on a recession. And you kind of look at what would’ve happened if you were one of those individuals where you would’ve pulled your money out and put it to cash at the beginning of this year, even if you put it in one of those CDs getting 5%.
The All Country World Index as of here, as we record in late September, it’s up about 11% this year and we haven’t seen that those recession fears come to fruition yet. So again, I think it’s just here recently. I think we can get very caught up into that shiny new object and trying to say, “Yep, this is going to be the one. I can absolutely see it. Market’s going to crash and I’m going to time it right.” And I think it’s just another case of well, just how hard and how [inaudible 00:08:51] it is to try to do it within just here recently.
And I’m not saying that I have any idea where the market’s going, going forward or how that trade’s going to come out, but the data’s been pretty clear over that rolling 12-month period. And I think we’ve done a number of podcasts on the behavioral side of investing. If you remember, Walt, just getting back into the emotions of investing and some of the common mistakes and really as investment professionals, well what are we trying to be leery of and avoid as we’re going in and developing portfolios? And not only do I think when individuals get into this whole timing and thinking that they can, it’s almost, we call it illusion of control bias. Have you heard that one before?
The illusion of control bias. Yeah, yeah. Heard of that control bias-
That’s essentially just how it is, right? You got it. So just basically saying, “Hey, investors and analysts and portfolio managers believe that they have more control over the outcome of their portfolio and their investments than they actually do.” And it’s very apparent. I mean, really just last week I had spoke with an individual, we’ll call him Sam. And Sam actually found us on our website and asked for a quick call and wanted to see about our services.
And this is pretty typical for anyone that’s looking into True Wealth and starting to work with us. .Normally what happens is we’ll set up a quick 15-minute phone call just to discuss, “Hey, what are you looking to accomplish? What do you want to do? Is it a good fit? And how might we be able to help?” So Sam had went through that process and I was talking to him last week and he was very, very adamant in that he wanted investment advice from us and he wanted us to give him a list of investments that we thought would be prudent in his situation, and then he would go back and take that list of investments that we recommended and go and implement them on his own terms or his own timing.
And I think that kind of alludes to this whole illusion of control or this whole market timing like, “Hey, if I just had the data, I just had the perfect investment, I could go back and I can choose when to buy and sell and when to get out of the investment.” And I think there’s a number of issues with Sam’s train of thought when he’s kind of thinking about working on the relationship that way.
That is just saying, “Hey, point in time, give me a list of the best recommendations to choose from.” Almost like that old broker list, if you’ve ever heard or watched any of the old school shows where they’re like, “Hey, I’ll come into my meeting. I got my 10 best stock picks here for you and we’re going to go and try to get you into one of them.”
I was just watching, Wolf of Wall Street, just the other day. So it’s reminding me of that.
Not a bad movie. Pretty entertaining, by the way, if none of the listeners have seen it. But when you think about building a portfolio and where I think Sam’s maybe missing the point a bit is that a key component into building a portfolio is understanding how those individual investments work together to an end goal, right? We want to maximize return and minimize risk. And when you start cherry picking investments with no thought on how they work together and how they move together, I think it leads to just bad portfolio results over time.
And you think about that point in time advice, there’s really no investment process or framework in place to help Sam kind of manage that going forward, right? He’s got his list that we would’ve given him. He’s got all these good investment picks he thinks and then he goes and implements them. Well, what happens six months down the road? What happens a year down the road, two years down the road? Is he going to hold those investments those entire time? How’s he going to get out of them? How’s he going to sell them and how are they going to work together?
I think this goes back to one of the key principles that some individuals miss when they are thinking about their portfolio is, what is your process? What is your investing framework, we call it? And essentially it’s, “Well, how are you managing in that portfolio on an ongoing basis? And what rules do you have put in place to protect you when inevitably the market becomes volatile or inevitably an investment doesn’t perform the way you expect? What is your rules and your process for analyzing and deciding, should I continue to hold this or should I not?”
And I know Kevin’s done a multitude of podcasts on True Wealth’s investing process, so if anyone would like to get into that. I think it goes back all the way to … Oh, one of the early episodes, Walt. I think back to Episode 27, where we started to do a three-part series on our investing process. So if anybody wants to, they can go back and check that out.
We’ll put a link to that in the show notes, of course. Yeah, back 27 through 30, a four-part series we did on that.
Okay. And then I think another big thing that Sam might’ve been missing here is that he was very specific that he wanted to look at his investments in the silo. It wasn’t how are these investments going to work to accomplish his goals? How is he going to help work to eliminate or lower his tax situation? None of that. It was purely looking at the investments in a silo. And I think not having that full picture and not having some type of understanding on why are we investing, what are we trying to accomplish, is really going to set you up for failure.
And what I mean by that is we kind of go back to the article a bit in the study that Morningstar put out when you get down in the weeds on it a little bit more. One of the clear takeaways of the study is that investors are actually more likely to mistime their investments in highly volatile funds than in less volatile funds. Some listeners might be saying, “Well that makes sense to me,” right? The investments that are going up and down more frequently.
If you’re trying to time it and you make a bad decision, “Hey, that’s going to hurt a little bit more.” But I would say even taking it one step further. It kind of gets back into those emotional biases and how we think about investing and how individuals think about their portfolio. And the fancy term that comes to mind for me is what’s called prospect theory.
And essentially, Walt, that’s where investors value gains and losses differently. And it’s really clear in the data that the average investor, those losses hurt more than gains feel good. And I’ll say that again to make sure that hits home. Losses hurt more than gains feel good. Which sort of makes sense, doesn’t it, Walt? When no one likes to see their portfolios-
That feels very accurate.
Mm-hmm. So you start thinking about those volatile investments or those investments that have a little bit more volatility with them. Well, when you see and you get that statement and you go, “Wow, I’m down whatever percentage that it is,” that hurts. And if you haven’t done the front end work to help you during times like that, I think we’re going to start leading with emotion and then making those investment decisions or maybe even making changes based on that fear or that emotional side of things of, “Hey, I need to stop the bleeding. I don’t want my investments to go down anymore.”
And one of the things that I think is really helpful as we think about going through volatile market periods is having a plan and having done some of that upfront work to help avoid making those emotional decisions. And as I think about that, what comes to mind for me, Walt, it’s like, “Well, you should know what return you need to get on your portfolio to accomplish your goals.” You do that long projection out and you start to think through how you want to spend your money, whether it’s, “Hey, I just want to get through retirement.” Or, “Hey, I want to leave a certain amount to the family when I pass away.”
Whatever it is, what return do you need to get on your portfolio to accomplish those goals? That way we can start to be deliberate and start thinking about, well, historically speaking, what type of portfolio would you need to have to accomplish that rate of return? You should also know how your portfolio will likely perform under bad market conditions. We call that a bear market test. I think about your hike, Walt and we were talking about it beforehand. And I was like, “How many bears are running around there?”
And you’re like, “Ah, it’s the moose.” But we call this a bear market test and essentially it’s saying, “Hey, when you look at your portfolio, how would it have performed back in 2008 when we went through the great financial crisis?” And not only how would it have performed, but how much in dollars and cents would your account have dropped, okay?
And doing some of that work upfront, well, when you get that statement and you see the negative number, you can go back right inside of your plan, look at that bear market test that you look at every single year and say, “Yep, that’s still within range of that worst case scenario. And all of those goals and all those things that I want to accomplish, they’re not in jeopardy.”
And I think having that back and work to fall back on will help ease your mind a little bit as you start seeing those statements and you start seeing that volatility and going, “All right. Hey, I got to try to time this. I’m going to get out and then I’ll jump back in.”
Yeah, it’s helpful. And I think a lot of this comes back to also realizing that when the market’s down, this doesn’t count as market timing, right? But then viewing opportunity when the market goes down. So it’s not all bad news, it’s not all worth panicking over when the market has corrections or goes down or is an unexpected result for what we kind of were hoping it would be maybe when we went in with our investments, whether we had those goals in place or not that you’ve talked about
Hearing you say it, right? It’s like how to maximize a bad market. Almost like, wait, what? But no, you’re absolutely right. It’s how do you make a bad situation better? Well, it’s understanding and saying when you are going through those volatile times and let’s say you’re in retirement, well having a pot of money that you know that you can pull from during those times without selling out of the more volatile investments when they’re down, that’s going to add some comfort.
We call it a runway. We’ve spoke on it many a times throughout some historical podcasts and thinking of it as this runway, right? How many years of spending do you have set aside in your portfolio that’s in safer, less volatile investments that you can pull from, if need be? Another one is tax loss harvesting. For those families that have investments outside of retirement accounts and you have investments that you might’ve just gotten into or whatnot and if you have some losses there, well can you realize those losses to offset some of your tax situation for that year?
Another big one, Walt, is really just simply rebalancing your portfolio and simply put rebalancing your portfolio as saying, “Hey, I started the year with X amount in stocks and X amount in bonds and this is what I needed to accomplish my goals.” And six months to a year later, maybe those stock positions are down quite a bit. It’s having the discipline to go in and rebalance and put more money back into some of those investments that are down.
So that way when inevitably we see a bounce back, you’re able to ride that upswing and you’re able to come back in at a risk level that you originally started with. Because if we don’t, well you’re not going to come back nearly as fast because you have less amount in those investments that were down. I think rebalancing is key and rebalancing with a process, right? And how do you do that rebalancing and how do you pick and choose your times to rebalance?
And another big one here on my list as I think about, again, maximizing that bad market scenario. “Hey, where are you going to pull your money from? Tax lost harvesting, rebalancing the portfolio?” But another big one’s Roth Conversions. I think just about every year in Q4 what we probably have our annual Roth Conversion podcasts and just reiterate just all the benefits that could come out of handling those Roth Conversions.
But you think about the timing of those. Well, if you do a Roth Conversion when your investment portfolio is down, well, you’re converting more shares at a less amount and then hopefully your higher expected return once that money’s in a Roth and all that, of course, growth inside of the Roth is tax free. So those are just a handful. You can look back on a few episodes where we kind of dive into a multitude of things you can be looking at when you experience those bad markets. But I think one thing we don’t want to do is kind of put our head in the sand, not look at your statements and not make any changes at all because we are missing potentially some opportunity to limit that downside.
Very good. It’s all helpful, I think, to put these things into perspective, Tyler. And the thing that keeps circling back to me is all about the plan and those goals. How can you know that you’re not supposed to panic when the market goes down or how do you know when to sell or not sell if you don’t have that plan in place and those expectations? It always comes back to that doesn’t it?
Mm-hmm, it does. Well, I think back to Sam, right, and him wanting to get that investment advice and look at it in a silo. It’s like, “Well, if we do that, what is he going to have to rely on when he does go through those volatile times?” He doesn’t have the plan in place. He hasn’t done the upfront work to understand, well, how much volatility would I have in my portfolio? What losses could I experience and how is this going to impact what I’m trying to accomplish?
All those things in conjunction, I think, are extremely valuable to help you make better decisions for the long run, right? And we’re coming to the end of the podcast here and we’ve covered a few different things, gone back and forth and we’ve rattled off a lot. And obviously the big thing to write down, well I’ll just say, “Don’t try to time the market.” If you garner anything from the podcast today, it’s that, “Hey, don’t try to garner the market.”
But I think number two is, well, hey, have you done the upfront work to put yourself in a good situation to where when you inevitably experience this or when you get that urge to say, “Hmm, should I just sell everything out to cash right now? Is now a good time to do that?” You can have that plan to rely on and kind of take some of that emotion out of it and say, “Hey, what’s going to be the best decision for me long-term?” So that way you don’t get caught up into some of those short-term fluctuations or short-term goals.
Well, appreciate you walking us through these conversations today, Tyler. And if anybody has questions for Tyler and the team at True Wealth Design, it’s very easy to get in touch and put together the kind of plan that helped Sam in our story today. Put together the kind of plan that’s going to help you have a lot more confidence as you approach retirement or as you just navigate some of the major financial decisions that you have to make in life.
Go through the planning process with the True Wealth Design team but it all starts with a quick conversation, 15-minute call with an experienced advisor on the team. See if you’re a good fit to work with one another. You can set that up by going to true wealthdesign.com. That’s truewealthdesign.com. And click on the, ARE WE RIGHT FOR YOU button and that’ll help you schedule that 15-minute call.
All you have to do again is go to truewealthdesign.com and click ARE WE RIGHT FOR YOU. You can also give a call to the team at 855-TWD-Plan. That’s 855-TWD- Plan. And we’ll put the contact information in the description of today’s show as well as links to check out those previous episodes that we mentioned during the program today as well, that Investing Process Series, as well as that what to do during a market decline episode that we did a few years back as well. A lot of that advice still applies.
Well, thank you so much for all of your help, Tyler, and I hope you have a great rest of your week and we’ll be talking to you soon.
All right, sounds good. That’s Tyler Emrick. I’m Walter Storholt. We’ll see you next time. Right back here on Retired Smarter.
Information provided is for informational purposes only and does not constitute investment tax or legal advice. Information is obtained from sources that are deemed to be reliable but their accurateness and completeness cannot be guaranteed. All performance references, historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.