Folks investing for retirement earned healthy returns over the past decade, but they could have done better, according to a recent report from Morningstar.
The average dollar invested in mutual funds or exchange-traded funds earned a 7% annual dollar-weighted return over the 10 years ending on Dec. 31, 2024.
Although that is not bad, it lags the 8.2% aggregate annual total return over the same decade. This “gap” occurred due to the timing and magnitude of transactions that investors made during the timeframe.
A gap of 1.2 percentage points might not seem large, but over time it can make a huge difference in how much you save for retirement. As we have reported in the past, missing out on as little as 1% in returns can cost you tens of thousands of dollars — or more — over a period of decades.
This 1.2-percentage-point gap is equivalent to about 15% of the funds’ aggregate total return during the same 10-year period, Morningstar says. Thus, it’s possible investors are overestimating their returns by a similar amount.
It is also roughly in line with the gaps reported during the 10-year periods ending in 2023, 2022, 2021 and 2020, according to Morningstar. That indicates the gap is persistent, suggesting a key flaw in how savers invest.
In a summary of its findings, Morningstar notes that the persistence of this gap is similar to how, for many decades, investors needlessly purchased mutual funds with excessively high expense ratios:
“But just as investors have learned to shop around for the cheapest funds, investors who are deliberate about the necessity, timing, and nature of transactions can ensure they capture as much of their funds’ returns as possible.”
If you are struggling to avoid bad behaviors that shrink your investment returns, Morningstar suggests taking a second look at target-date funds, which automatically adjust your asset allocation to a more conservative mix as you near the target date, which is usually around the time you plan to retire.
Morningstar’s research found that those who stuck to such all-in-one funds have “had more success capturing the total returns.” On the other hand, those who invested in specialized funds — such as sector equity funds, which focus on a particular industry or sector of the economy — tended to struggle.
Morningstar also found that the more investors traded, the less they made in returns. In particular, those who invested in especially volatile funds appeared to be at bigger risk of mistiming both purchases and sales. The firm concludes:
“This argues to hold fewer, widely diversified funds that automate routine tasks like asset allocation and rebalancing, obviating the need for investors to take action.”
For more tips on how to be a smarter investor, check out “3 Habits That Successful Everyday Investors Swear By.”
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