October 15, 2025 • 14 mins
Are you underperforming our own investments? Did you know that many, maybe even most, investors do worse than the ETFs and Mutual Funds they hold do? The annual Morningstar study “Mind the Gap” has found a substantial difference between returns generated by investment funds and the actual returns investors experience.
Jeffrey Ptak is the managing director at Morningstar. Previously, he was the chief ratings officer.
Each week, “At the Money” discusses an important topic in money management. From portfolio construction to taxes and cutting down on fees, join Barry Ritholtz to learn the best ways to put your money to work.
See omnystudio.com/listener for privacy information.
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:02):
Bloomberg Audio Studios, podcasts, radio news.
Speaker 2 (00:29):
What would you say if I told you that most
investors underperform not only the benchmarks, but their own investments.
That's the conclusion of an annual study by morning Star
titled Mind the Gap. It examines the differences between returns
generated by investment funds and the actual returns investors experience.
(00:56):
The difference between the two, it's a substantial performance gap,
driven in large part by investor behavior. I have the
perfect person to discuss this with. Jeffrey Pattak is the
managing director at morning Star. Previously he was the chief
ratings officer there. He joined morning Store way back in
(01:16):
two thousand and two. So, Jeffrey, let's start with the basics.
What is the investor return gap and how large is it?
Speaker 3 (01:26):
Yeah, so, first off, thanks so much for having me.
I'm a big fan of the podcast. So the investor
return gap is the difference between our estimate of the
average return of a funder or a group of funds
and that funds. It's total return, it's stated return. What's
the difference between the two of those things. The former
takes into account the timing and magnitude of cash flows
(01:47):
that have come and gone to and from the fund
over time, whereas a total return, which most of us
are familiar with from popping out up Bloomberg dot com
or Morningstar dot com assumes an initial lump sum investment.
And so when you compare the two of them, you
can derive a sense of the impact of the timing
and magnitude of buys and sells over time. To cut
(02:08):
to the chase, when we estimated that for the trailing
ten years and to December thirty first, twenty twenty four,
we found that there's a one point two percentage point
annual return gap compared to the funds aggregate total returns. So,
in essence, what that meant is that the timing and
magnitude of cash flows basically cost investors around fifteen percent
(02:29):
of their aggregate total returns.
Speaker 2 (02:31):
That's unbelievable. That's a giant, giant shortfall. How do you
calculate that gap? How do you figure out? I mean,
it's easy to figure out what a fund, an ETF,
a mutual funds is actually generating. How do you figure
out the shortfall that individual investors are suffering?
Speaker 3 (02:49):
Yeah, great question. It's akin to an internal rate of return. Estimate.
So we pull all US open end fund and ETF
assets together, so that's their beginning that assets. They're monthly flows,
so that's one hundred and twenty monthly netflows that we
impound into the calculation, as well as their ending net assets.
We dump all of that into a calculation that derives
(03:11):
essentially the concert return that would reconcile the beginning assets
to the ending assets after taking those cash flows into account.
All the data we use is data that morning Star collects.
So funds support their assets as well as their flows,
and so we scoop that up and we plug it in.
Speaker 2 (03:26):
So what sort of funds does this include? I assume
this is mutual funds and ETFs. Anything else in the package.
Speaker 3 (03:35):
You got it. It encompasses US open end mutual funds
as well as ets. It wouldn't include things like closed
end funds. In all, there were around twenty six thousand
individual funds and ETFs that together held around twenty five
trillion dollars in assets by the end of our study period,
so it's quite a comprehensive study.
Speaker 2 (03:56):
I'm fascinated by the difference between timewaighted rate of returns
for funds and acid weighted returns. Explain the two, because
really that makes a giant difference, doesn't it It does.
Speaker 3 (04:09):
Indeed, yes, your listeners are probably familiar with time weighted
returns because that's what they'd encounter in their normal affairs.
So I mentioned earlier, if they were to pop on
to Bloomberg dot com or Morningstar dot com pull up
a funds performance, those are time weighted return figures. The
more popular parerlance is total returns and a time weighted return.
It assumes an initial lump sum investments that's left untouched
(04:31):
until the end of the period. It's sort of your
classic buy and hold. Where's a dollar weighted return that
takes the timing and magnitude of investors purchases and sales
into account. It doesn't assume people invest in initial lump
sum and hold it to the end like a total
return does. And so that's essentially the difference between the
two measures.
Speaker 2 (04:49):
I've seen some interesting studies on hedge funds and on
some ETFs where the timeway to return makes it look
like a manager has done really well, and then when
you see the dollar way to return, most of the
assets tend to flow in after they've had a big
run up after the media has focused on them. Some
(05:11):
hedge fund managers that look like they have great track
records in terms of how well they've done for their
investors are actually net losers over time. Do you see
things that extreme when you're looking at this data?
Speaker 3 (05:26):
We do, indeed, unfortunately, I will say in aggregate, on
balance investors have gotten better, and we can talk about
some of the reasons for that, about capturing more of
their funds total returns than was formerly the case. But yes,
we do see some of these vivid examples of investors
Schematically they're buying high end selling low. You know, it's
(05:47):
sometimes it's chasing behavior where investors pile in just as
you describe after a fund goes in a strong run,
only for performance to roll over, at which point they
bail out, you know, and that can work in reverse
where they sell before performance impruse. Both of those things
would dent their dollar weighted returns compared to the fund's
total return.
Speaker 2 (06:07):
So it sounds like behavioral factors are a cause for
investors suffering actually lower returns than their fund's total return.
What other behaviors do you see that are a net negative?
Speaker 3 (06:22):
You know, I mean I think that you sometimes it
can be quite mundane where you will see an investor
or someone you know representing them decide that they want
to change the asset mix. And so it might not
be in response to a particular funds performance. It could
be that for whatever reason, they just decide that they
want to be positioned differently, and so maybe they put
(06:43):
more exposure on in an area that's outperformed and take
some weight off in an area that's underperformed, only to
see that wrong foot them over subsequent periods. And so
those are the sorts of decisions behaviors that can give
rise to gaps.
Speaker 2 (06:59):
Yeah, version is a cruel mistress. What about different types
of funds when we look at market cap size or
geography US versus international? How does the gaps form in
those types of things?
Speaker 3 (07:15):
Great question, Barry. Those are some of the dimensions that
we look at as part of the study. Sector equity
funds have chronically suffered the widest gaps in absolute terms.
In our most recent study, the average dollar invested in
sector equity funds lagged the funds total returns by one
and a half percentage points a year over the over
the decade ended December thirty first, twenty total, which meant
that investors failed to capture around twenty percent of those
(07:38):
funds aggregate returns. By contrast, we've seen the narrowest gaps
among allocation funds in the most popular example of which
are target date strategies. Those funds barely had an investor
return gap over those ten years ended December thirty first,
twenty twenty four. So the other thing, I would notice
that ETFs had wider gaps than traditional open end funds.
(07:59):
We include both in the study. Over the ten years
out of December twenty four, the average shower invested in
ETFs lag the ets aggregate total return by around one
point seven percentage points annually, which is equivalent fron eighteen
percent of the ETF's total returns. Open end funds, by contrast,
data narrower one point two percentage point per year gap
over that timeframe. So ETFs are great in a lot
(08:22):
of different ways. We just want to make sure that
we use them in the most prudent fashion.
Speaker 2 (08:26):
That makes sense. ETFs are a trading vehicle for some people,
and we know what the long term results of most
people's active trading is. Like, I'm curious how do the
international funds stack up against domestic funds in terms of
the gap?
Speaker 3 (08:43):
Very good question. The gap was slightly wider for international
funds than it was for domestic equity funds. So we
found that there was a one point one percentage point
annual gap, whereas for US equity it was about half
that was it was about half a percentage point zero
point six percentage points to be precise.
Speaker 2 (09:03):
And what role does market volatility play in this gap widening?
I recall earlier this year when the tasks were rolled
out in April, we saw a lot of frenetic activity.
You can help but look at that and imagine very
few people got that right.
Speaker 3 (09:22):
Yeah, right, you are. Our research has found a correlation
at a couple levels. At an overall market macro level,
as you allude to, market fluctuations do tend to push
investors buttons. They're much likelyer to make changes to their
holdings and this can work to their detriment and dollar
weighted terms. We also look at this at an asset
class level, you know, so US equity, international equity, taxable bonds,
(09:44):
and on and on. We also find there that the
more volatile funds of a particular type have been harder
for investors to successfully use them less volatile funds, and
so there are wider gaps with those hotter to handle,
too hard to handle funds that you would find in
say US equity or taxable bond as compared to their
(10:04):
more sedate counterparts within those asset classes. And so that's
been another sort of perennial finding from the study is
that volatility pushes investors' buttons, and when it does so,
they tend to capture less of their funds total returns.
Speaker 2 (10:18):
You mentioned target date funds. I tend to think of
target date funds or balance funds typically in four to
oh one K or retirement plans where most people have
a tendency to set and forget and just dollar cost
average on a regular basis with each paycheck. Generally speaking,
(10:39):
do we see less of a gap in retirement funds?
Is it because of the specific long term nature of
target date funds or the fact that it's a in
a four to oh one K or four H three B.
What's the advantage balance funds target date funds have, YEP.
Speaker 3 (10:58):
I would say there's two principal advantages. One is contextual,
the other is related to the attributes the characteristics of
those strategies. Let's talk context first. They're most often used
in the context of a retirement plan. It's a gilded
cage of sorts. It's really meant for investors to go
in and save and compound over time, not for them
(11:18):
to wheel around as they might in a brokerage account.
Then let's talk about the characteristics of those vehicles. As
you reference, they're highly automated, They take care of rebalancing,
they adjust the asset mix as time goes on. They
are as you put it, set it, and forget it,
and that has worked to investors benefit. We found that
(11:39):
investors in allocation funds they captured essentially all of their
funds total returns. That is, there was almost no gap
among allocation funds over the ten year study period that
we were focused on. And so I think that's one
of the most heartening stories to come out of our
research is the fact that it seems that investors in
retirement plans are specifically those who invest in allocation funds,
(12:01):
have enjoyed some of the greatest success and that's crucial
to their retirement security.
Speaker 2 (12:06):
So give investors some practical advice, what sort of steps
can they take to minimize the gap capture more of
their investing funds long term returns.
Speaker 3 (12:18):
Yeah, it's a great question. So it might sound a
bit tripe, but I would say, have a plan and
automate as much of it as you can. Investors, they
tend to get themselves in trouble when they engage in
off cycle discretionary ad hoc type of trading. You know
what might that happen is you can probably imagine it's
likelier to occur when there's some sort of market disruption
(12:39):
or tumult or a minimania. But if you have a
plan and you've appropriately allocated your assets based on that plan,
you know, widely diversifying across asset, then you have an
anchor or a point of orientation, whereas without it you
might feel like you're at c You know, also, because
you've spread out for the plan diversifying, why you're less
likely to experience the brunt of a sell off and
(13:02):
experience the kind of ruin US outcome that might induce panic.
Automating is the other key. I would say. You know
what we know about target date funds is they're held
in retirement plans. Yes, but also they obviate the need
for investors to take action to rebalance or to adjust
the asset mix as they were near the retirement date.
And that's because those features are built in, so, you know,
(13:24):
I think one of the other clear takeaways from the
research is that automation narrows gaps.
Speaker 2 (13:29):
So to wrap up, investors can avoid the investor gap.
They can avoid underperforming their own mutual funds and ETFs
by simply having a couple of common sense steps put
into place. Don't let volatility distract you. Don't try and
buy or sell when markets get frothy, don't think you're
(13:52):
going to be able to time the market. And perhaps
most important of all, you have to have a plan
and you have to be able to keep your emotions
at bay, otherwise you're going to fall into the unfortunate
fate of underperforming your own investments. I'm Barry Ridolts. You're
listening to Bloomberg's At the Money
Bloomberg Audio Studios, podcasts, radio news.
Speaker 2 (00:29):
What would you say if I told you that most
investors underperform not only the benchmarks, but their own investments.
That's the conclusion of an annual study by morning Star
titled Mind the Gap. It examines the differences between returns
generated by investment funds and the actual returns investors experience.
(00:56):
The difference between the two, it's a substantial performance gap,
driven in large part by investor behavior. I have the
perfect person to discuss this with. Jeffrey Pattak is the
managing director at morning Star. Previously he was the chief
ratings officer there. He joined morning Store way back in
(01:16):
two thousand and two. So, Jeffrey, let's start with the basics.
What is the investor return gap and how large is it?
Speaker 3 (01:26):
Yeah, so, first off, thanks so much for having me.
I'm a big fan of the podcast. So the investor
return gap is the difference between our estimate of the
average return of a funder or a group of funds
and that funds. It's total return, it's stated return. What's
the difference between the two of those things. The former
takes into account the timing and magnitude of cash flows
(01:47):
that have come and gone to and from the fund
over time, whereas a total return, which most of us
are familiar with from popping out up Bloomberg dot com
or Morningstar dot com assumes an initial lump sum investment.
And so when you compare the two of them, you
can derive a sense of the impact of the timing
and magnitude of buys and sells over time. To cut
(02:08):
to the chase, when we estimated that for the trailing
ten years and to December thirty first, twenty twenty four,
we found that there's a one point two percentage point
annual return gap compared to the funds aggregate total returns. So,
in essence, what that meant is that the timing and
magnitude of cash flows basically cost investors around fifteen percent
(02:29):
of their aggregate total returns.
Speaker 2 (02:31):
That's unbelievable. That's a giant, giant shortfall. How do you
calculate that gap? How do you figure out? I mean,
it's easy to figure out what a fund, an ETF,
a mutual funds is actually generating. How do you figure
out the shortfall that individual investors are suffering?
Speaker 3 (02:49):
Yeah, great question. It's akin to an internal rate of return. Estimate.
So we pull all US open end fund and ETF
assets together, so that's their beginning that assets. They're monthly flows,
so that's one hundred and twenty monthly netflows that we
impound into the calculation, as well as their ending net assets.
We dump all of that into a calculation that derives
(03:11):
essentially the concert return that would reconcile the beginning assets
to the ending assets after taking those cash flows into account.
All the data we use is data that morning Star collects.
So funds support their assets as well as their flows,
and so we scoop that up and we plug it in.
Speaker 2 (03:26):
So what sort of funds does this include? I assume
this is mutual funds and ETFs. Anything else in the package.
Speaker 3 (03:35):
You got it. It encompasses US open end mutual funds
as well as ets. It wouldn't include things like closed
end funds. In all, there were around twenty six thousand
individual funds and ETFs that together held around twenty five
trillion dollars in assets by the end of our study period,
so it's quite a comprehensive study.
Speaker 2 (03:56):
I'm fascinated by the difference between timewaighted rate of returns
for funds and acid weighted returns. Explain the two, because
really that makes a giant difference, doesn't it It does.
Speaker 3 (04:09):
Indeed, yes, your listeners are probably familiar with time weighted
returns because that's what they'd encounter in their normal affairs.
So I mentioned earlier, if they were to pop on
to Bloomberg dot com or Morningstar dot com pull up
a funds performance, those are time weighted return figures. The
more popular parerlance is total returns and a time weighted return.
It assumes an initial lump sum investments that's left untouched
(04:31):
until the end of the period. It's sort of your
classic buy and hold. Where's a dollar weighted return that
takes the timing and magnitude of investors purchases and sales
into account. It doesn't assume people invest in initial lump
sum and hold it to the end like a total
return does. And so that's essentially the difference between the
two measures.
Speaker 2 (04:49):
I've seen some interesting studies on hedge funds and on
some ETFs where the timeway to return makes it look
like a manager has done really well, and then when
you see the dollar way to return, most of the
assets tend to flow in after they've had a big
run up after the media has focused on them. Some
(05:11):
hedge fund managers that look like they have great track
records in terms of how well they've done for their
investors are actually net losers over time. Do you see
things that extreme when you're looking at this data?
Speaker 3 (05:26):
We do, indeed, unfortunately, I will say in aggregate, on
balance investors have gotten better, and we can talk about
some of the reasons for that, about capturing more of
their funds total returns than was formerly the case. But yes,
we do see some of these vivid examples of investors
Schematically they're buying high end selling low. You know, it's
(05:47):
sometimes it's chasing behavior where investors pile in just as
you describe after a fund goes in a strong run,
only for performance to roll over, at which point they
bail out, you know, and that can work in reverse
where they sell before performance impruse. Both of those things
would dent their dollar weighted returns compared to the fund's
total return.
Speaker 2 (06:07):
So it sounds like behavioral factors are a cause for
investors suffering actually lower returns than their fund's total return.
What other behaviors do you see that are a net negative?
Speaker 3 (06:22):
You know, I mean I think that you sometimes it
can be quite mundane where you will see an investor
or someone you know representing them decide that they want
to change the asset mix. And so it might not
be in response to a particular funds performance. It could
be that for whatever reason, they just decide that they
want to be positioned differently, and so maybe they put
(06:43):
more exposure on in an area that's outperformed and take
some weight off in an area that's underperformed, only to
see that wrong foot them over subsequent periods. And so
those are the sorts of decisions behaviors that can give
rise to gaps.
Speaker 2 (06:59):
Yeah, version is a cruel mistress. What about different types
of funds when we look at market cap size or
geography US versus international? How does the gaps form in
those types of things?
Speaker 3 (07:15):
Great question, Barry. Those are some of the dimensions that
we look at as part of the study. Sector equity
funds have chronically suffered the widest gaps in absolute terms.
In our most recent study, the average dollar invested in
sector equity funds lagged the funds total returns by one
and a half percentage points a year over the over
the decade ended December thirty first, twenty total, which meant
that investors failed to capture around twenty percent of those
(07:38):
funds aggregate returns. By contrast, we've seen the narrowest gaps
among allocation funds in the most popular example of which
are target date strategies. Those funds barely had an investor
return gap over those ten years ended December thirty first,
twenty twenty four. So the other thing, I would notice
that ETFs had wider gaps than traditional open end funds.
(07:59):
We include both in the study. Over the ten years
out of December twenty four, the average shower invested in
ETFs lag the ets aggregate total return by around one
point seven percentage points annually, which is equivalent fron eighteen
percent of the ETF's total returns. Open end funds, by contrast,
data narrower one point two percentage point per year gap
over that timeframe. So ETFs are great in a lot
(08:22):
of different ways. We just want to make sure that
we use them in the most prudent fashion.
Speaker 2 (08:26):
That makes sense. ETFs are a trading vehicle for some people,
and we know what the long term results of most
people's active trading is. Like, I'm curious how do the
international funds stack up against domestic funds in terms of
the gap?
Speaker 3 (08:43):
Very good question. The gap was slightly wider for international
funds than it was for domestic equity funds. So we
found that there was a one point one percentage point
annual gap, whereas for US equity it was about half
that was it was about half a percentage point zero
point six percentage points to be precise.
Speaker 2 (09:03):
And what role does market volatility play in this gap widening?
I recall earlier this year when the tasks were rolled
out in April, we saw a lot of frenetic activity.
You can help but look at that and imagine very
few people got that right.
Speaker 3 (09:22):
Yeah, right, you are. Our research has found a correlation
at a couple levels. At an overall market macro level,
as you allude to, market fluctuations do tend to push
investors buttons. They're much likelyer to make changes to their
holdings and this can work to their detriment and dollar
weighted terms. We also look at this at an asset
class level, you know, so US equity, international equity, taxable bonds,
(09:44):
and on and on. We also find there that the
more volatile funds of a particular type have been harder
for investors to successfully use them less volatile funds, and
so there are wider gaps with those hotter to handle,
too hard to handle funds that you would find in
say US equity or taxable bond as compared to their
(10:04):
more sedate counterparts within those asset classes. And so that's
been another sort of perennial finding from the study is
that volatility pushes investors' buttons, and when it does so,
they tend to capture less of their funds total returns.
Speaker 2 (10:18):
You mentioned target date funds. I tend to think of
target date funds or balance funds typically in four to
oh one K or retirement plans where most people have
a tendency to set and forget and just dollar cost
average on a regular basis with each paycheck. Generally speaking,
(10:39):
do we see less of a gap in retirement funds?
Is it because of the specific long term nature of
target date funds or the fact that it's a in
a four to oh one K or four H three B.
What's the advantage balance funds target date funds have, YEP.
Speaker 3 (10:58):
I would say there's two principal advantages. One is contextual,
the other is related to the attributes the characteristics of
those strategies. Let's talk context first. They're most often used
in the context of a retirement plan. It's a gilded
cage of sorts. It's really meant for investors to go
in and save and compound over time, not for them
(11:18):
to wheel around as they might in a brokerage account.
Then let's talk about the characteristics of those vehicles. As
you reference, they're highly automated, They take care of rebalancing,
they adjust the asset mix as time goes on. They
are as you put it, set it, and forget it,
and that has worked to investors benefit. We found that
(11:39):
investors in allocation funds they captured essentially all of their
funds total returns. That is, there was almost no gap
among allocation funds over the ten year study period that
we were focused on. And so I think that's one
of the most heartening stories to come out of our
research is the fact that it seems that investors in
retirement plans are specifically those who invest in allocation funds,
(12:01):
have enjoyed some of the greatest success and that's crucial
to their retirement security.
Speaker 2 (12:06):
So give investors some practical advice, what sort of steps
can they take to minimize the gap capture more of
their investing funds long term returns.
Speaker 3 (12:18):
Yeah, it's a great question. So it might sound a
bit tripe, but I would say, have a plan and
automate as much of it as you can. Investors, they
tend to get themselves in trouble when they engage in
off cycle discretionary ad hoc type of trading. You know
what might that happen is you can probably imagine it's
likelier to occur when there's some sort of market disruption
(12:39):
or tumult or a minimania. But if you have a
plan and you've appropriately allocated your assets based on that plan,
you know, widely diversifying across asset, then you have an
anchor or a point of orientation, whereas without it you
might feel like you're at c You know, also, because
you've spread out for the plan diversifying, why you're less
likely to experience the brunt of a sell off and
(13:02):
experience the kind of ruin US outcome that might induce panic.
Automating is the other key. I would say. You know
what we know about target date funds is they're held
in retirement plans. Yes, but also they obviate the need
for investors to take action to rebalance or to adjust
the asset mix as they were near the retirement date.
And that's because those features are built in, so, you know,
(13:24):
I think one of the other clear takeaways from the
research is that automation narrows gaps.
Speaker 2 (13:29):
So to wrap up, investors can avoid the investor gap.
They can avoid underperforming their own mutual funds and ETFs
by simply having a couple of common sense steps put
into place. Don't let volatility distract you. Don't try and
buy or sell when markets get frothy, don't think you're
(13:52):
going to be able to time the market. And perhaps
most important of all, you have to have a plan
and you have to be able to keep your emotions
at bay, otherwise you're going to fall into the unfortunate
fate of underperforming your own investments. I'm Barry Ridolts. You're
listening to Bloomberg's At the Money
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