People, in general, get emotional about money — especially the possibility of losing it. According to Nobel Prize-winning psychologist Daniel Kahneman, for most people, the fear of losing $100 is more intense than the prospect of gaining $150.
Risk-aversion can have its cost. And it’s not just missed opportunity.
Too often, emotion sparks irrational behavior, such as cashing out, chasing returns and jumping from fund to fund — essentially buying high and selling low, and locking in losses.
This may be a major contributor to recent findings by Morningstar®, Inc., which compared mutual fund returns with the gains investors actually received and found that investor returns typically lagged fund returns.1
The study covered 10 years through the end of 2016 and found that funds posted an average annualized return of 4.33%, compared with a 3.96% average return realized by investors. (Those totals factor in all stock and bond funds that Morningstar tracks. Investor returns are weighted based on asset flows into and out of all share classes of open-end mutual funds tracked by Morningstar.)
Although a gap of almost half a percentage point may not seem like a big difference, it can make a significant impact over the long term, thanks to compounding. In fact, a $10,000 investment returning an average of 4.33% annually would produce a total of $15,279 over 10 years, compared with $14,746 for an average annual return of 3.96% over the same period. Over 30 years, the gap becomes even wider: $35,668 for the 4.33% return vs. $32,062 for the 3.96% return.2
Another study, by Dalbar, Inc., noted an even bigger gap with average equity investor returns lagging those of the S&P 500 by 3.66%.3(Dalbar used data from the Investment Company Institute, Standard & Poor’s, Barclays Capital index products and proprietary sources to compare mutual fund investor behavior with an appropriate set of benchmarks. These behaviors were then used to simulate those of the “average investor.”)
A key to controlling behavior is understanding the emotion behind it. The knowledge and perspective you bring to the table can prove invaluable to clients who are overcome by fear.
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Content contained herein is not intended to serve as impartial investment or fiduciary advice. The content has been developed by Capital Group, which receives fees for managing, distributing and/or servicing its investments.
©2018 Morningstar, Inc. All Rights Reserved. Some of the information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar, its content providers nor the American Funds are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. Information is calculated by Morningstar. Due to differing calculation methods, the figures shown here may differ from those calculated by American Funds.