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Fund Operations

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Advising Clients

Morningstar Study Makes the Case for Buy and Hold

Jan Blakeley Holman, CFP, CIMA, ChFC, CDFA, CFS, GFS
Director of Advisor Education
11 Sep 2023
4 min read

Convincing clients to stay the course is one of your greatest challenges.

Morningstar recently released its annual “Mind the Gap” study, which compares investor returns to the returns generated by their mutual funds and Exchange Traded Funds (ETF). As was the case in previous studies, researchers reported that, over the 10 years ended December 31, 2022, investors’ returns were lower than their investments’ returns. They found that investors earned about 6% per year on the average dollar they invested in mutual Funds and ETFs compared to the 7.7% return generated by their investments over the same period.

The study also found that actively managed funds outperformed passive funds in six of the seven investment category groups they studied (the seventh, allocation funds were excluded because, by nature, they are primarily actively managed). While the total return for passive U.S. equity funds was higher than the total return generated by actively managed U. S. equity funds over the 10-year period, the gap between passive investor returns and passive investment returns was larger than the gap between active investor and investment returns

Explaining the performance difference between the active and passive returns, the authors of the study noted, “it reflects the enveloping trend that has seen assets move en masse from active to passive, with those shifts proving costly and beneficial, respectively for passive and active investors.”

Figure 1: Investor Return Gaps: Active Funds Versus Passive Funds

U.S. Category Group Management Style Investor Total Gap
Alternative Active 0.5 1.58 -1.07
Passive -17.84 -15.71 -2.13
International Equity Active 4.7 5.32 -0.61
Passive 1.03 3.91 -2.88
Municipal Bond Active 0.61 1.89 -1.28
Passive -1.53 1.67 -3.21
Nontraditional Equity Active 1.99 3.98 -1.99
Passive 5.62 8.91 -3.3
Sector Equity Active 7.22 9.83 -2.62
Passive 5.7 11.44 -5.74
Taxable Bond Active 0.71 1.68 -0.97
Passive -1.05 1.32 -2.37
U.S. Equity Active 11.24 11.47 -0.24
Passive 10.68 12.11 -1.43

Source: Morningstar Direct. Data as of 31 December 2022. Excludes allocation category group.

The Performance Predicament

Morningstar’s findings highlight an issue that has long plagued investors and investment professionals alike, the persistent gap between investor and investment performance in both actively managed and passive investments. The study estimates that overall, the average investor’s return of 1.67% less than the average fund return over the decade ended December 31, 2022, cost them almost 22% of the investment return they could have earned if they had adopted a buy and hold strategy.

Thanks to computerization and the internet, the financial services industry has done a wonderful job of giving investors access to their financial information at a moment’s notice. But daily access to performance information is a double-edged sword. On one hand, the value your clients’ investment portfolio is always available. On the other, because clients are regularly updated on their investment performance, it’s difficult for them to avoid making emotional decisions when volatile markets cause investment portfolios to steadily decline in value.

The tendency for investors to react to short-term events was confirmed by last year’s analysis for the New York Stock Exchange conducted by Reuters, that found the average investor’s holding period for stocks is 5.5 months. To add perspective, the holding period for some of Warren Buffet’s average investment holding period is 7 years and three of his investments have been held for more than 20 years.

We are a society that thrives on immediate gratification. As an advisor, you continually run into issues with clients who are used to immediate gratification. When it comes to investing, that mindset can derail even the best-laid plans. To help your clients stay the course and reap the rewards of long-term investing, here are some suggestions.

  • Design investment portfolios that are realistic.
    As a financial advisor, you’re in a best position to apply science and art to the portfolios you design. The science is asset allocation which enables you to model various investment models. The art is your experience and knowledge of your client and their tolerance for volatility.
  • Use a goals-based approach to discuss portfolio performance.
    Typically, your client’s most important goals are long-term in nature (5 or more years). To achieve those goals, they should own equities they must remain invested. Along the way, there will be market volatility, negative news, and events that will make them question the soundness of their investment strategy. To prevent them from making knee-jerk, emotion-driven decisions, tie sections of the portfolio to each of the goals and shift the focus from the entire portfolio performance to performance of each section.
  • Leave your biases at the door.
    You’re human. You have biases and you react to investment markets just like your clients. To provide them with the best possible advice, make objective investment recommends that reflect your combined knowledge, experience and expertise.

Don’t expect any different findings in future “Mind the Gap” reports. Investor returns will lag investment returns for years to come. While there’s nothing you can do to change the survey results, you are in a position to ensure your clients achieve their financial goals. What more could you ask for?

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