Mindfully Investing is predicated on the idea that individual investors can meet their investing goals without paying a financial adviser. However, I’ve also said that there’s nothing fundamentally wrong with using a financial adviser, just so long as you understand what the advisor charges in fees and/or a cut of the returns, and you’re knowledgeable enough to critically assess their advice. If you’ve read even a few of the articles here at Mindfully Investing, you know there are good reasons why individual investors can and do succeed on their own. For example, I’ve never used a financial adviser, and I was able to comfortably retire at the age of 52. And I don’t think I have any particularly special abilities or mindset. Nonetheless, I regularly see news, blog posts, and opinion pieces urging investors to seek professional advice lest they ruin their finances.
The Investor Gap
The so-called “investor gap” is often cited as Exhibit A in the case against solo investing. The investor gap is the difference between the returns of mutual funds or exchange-traded funds (ETFs) and the returns that investors in those funds actually receive. The idea that investors don’t receive all the after-cost returns from their fund investments sounds like some sort of complicated financial industry conspiracy, but the reason is simple. Individual investors often fail to get their fair share of a fund’s returns because they sell the fund, and perhaps buy it again later, rather than simply holding the fund through thick and thin. The assumption is that these additional fund transactions are an emotional response to market ups and downs. That’s undoubtedly true to some extent and I’ve previously described the emotional roller coaster that can cause unproductive transactions.
Let’s take a closer look at the investor gap, which is often mentioned in soft advertising published by investment adviser firms. Here’s an example from the quarterly guide to the markets by JP Morgan, one of the largest investment advisers in the world.
Nothing in the report explicitly tells the reader to pick up the phone and call JP Morgan because of the “average” investor’s apparently dismal returns performance. Instead, this graph merely implies the average investor is a turkey, while the rest of the 70-page report highlights JP Morgan’s expertise in investing and financial markets. Many firms calculate or present similar investor gap statistics without explicitly pitching their services. Like those “Got Milk?” commercials that never mention a particular brand, the entire adviser industry likes to perpetuate the idea that individual investors are congenitally incompetent. Maybe I should try to sell a “Got Gap?” advertising campaign to the adviser industry.
A Gap in The Facts
The JP Morgan graph is pretty damning of individual investors. While a simple S&P 500 index fund netted a 5.6% annualized return over the last 20 years, the hapless average investor reaped only a 1.9% annualized return, which is even less than the inflation rate over the same period. The gap between the average investor and the most common U.S. index fund is nearly 4% in annualized return. Ouch!
But these facts are more nuanced than they appear. As the fine print below the JP Morgan graph notes, the average investor data come from an annual investor gap report published by the DALBAR company. DALBAR sells its report to financial adviser firms, some of whom use the scarry statistics to directly or indirectly sell their services. But I noted back in 2017 that some perceptive researchers found discrepancies in DALBAR’s methods, which conveniently cause a bigger investor gap than some other studies. Instead of a DALBAR’s 4% investor gap, I’ve previously presented evidence that the investor gap is closer to the 0% to 2.5% range as shown in this table.
| Source | Investor Gap – Low | Investor Gap – High | Comments |
| Maymin and Fisher 2011. | -0.5% | -1.8% | Average from many fund types |
| Vanguard 2018 | -0.1% | -2.5% | Range across various stock funds |
| Morningstar 2019 | 0.2% | -1.4% | Range across many fund types |
Note the positive value of 0.2% from the Morningstar study. This means that for one type of fund (“allocation funds” that contain a mix of stocks and bonds) the average investor achieved slightly superior returns to the fund itself. So, maybe we aren’t all complete turkeys after all. Regardless, these other studies still show that individual investors most often miss a small to substantial portion of the return produced by the funds in which they invest.
Gap Dynamics
The other nuance to be aware of is that the investor gap changes over time, most likely due to changes in market conditions. For example, here’s a graph from the Maymin and Fisher study showing their calculation of the gap over several years (in this case, positive values indicate that the average investor did worse than the fund).
The gap between the average investor’s returns and the funds themselves surged noticeably during the market crashes of 2000 and 2009, presumably when more investors panicked and sold their funds, at least temporarily. This observation is backed up by the 2018 Morningstar study, which showed a relationship between the investor gap and the volatilities of the funds involved.
Overall, the data show that the more volatile funds have a more negative investor gap. It’s worth noting again that the gaps for two of the allocation funds are positive, meaning that in some cases the average investor performed better than their fund’s returns.
A Gap Mirage?
It turns out that the investor gap is more complicated than you might have initially thought. We’ve seen that the size of the gap varies depending on who’s doing the calculation, the calculation method, the type of fund involved, the period used, and the market conditions during that period. And it gets worse. Jake at Econompic challenges the underlying assumption that individual investors mainly buy and sell funds for emotional reasons like panic selling. He notes several perfectly logical reasons why investors might make additional fund transactions including:
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- Rebalancing
- Demographics (For example, older investors may sell to generate income in retirement. Or investors may move into less risky funds as they age.)
- Shifts from more active to more passive funds
- Shifts from mutual funds to ETFs
- Shifts from higher- to lower-cost funds.
Jake presents some pretty compelling evidence for why transactional “flows” of money between funds (and to other destinations) indicate a sometimes negative and sometimes positive correlation between the investor gap and bad behavior. That is, these other flows can easily cause the investor gap to narrow or widen substantially, regardless of how emotionally investors act at any given time.
So, if the total “investor gap” ranges roughly between 0 to 2.5%, the “bad behavior gap” is only a portion of that. Because of limitations in the data used in these calculations, there’s no way to measure how much the bad behavior gap contributes to the total investor gap. The bad behavior gap may cause less than half of the total gap. Or more likely, the contribution from bad behavior changes over time. Your guess is as good as mine.
Conclusions
Even though the bad behavior gap may be considerably smaller than any of these studies found, the “average” investor still likely experiences some kind of return gap due to emotional and unproductive transactions. And the existence of any behavior gap validates the advantages of mindful investing, which is founded on the four cornerstones of rationality, empiricism, humility, and patience. Managing our emotional reactions to market gyrations through mindful practices will reap benefits in the form of better long-term returns, even though the benefits may only be incremental.
Further, because the bad behavior gap is smaller than typically portrayed, investment advisers have a harder time offering a value proposition. The smaller the gap truly is, the more the adviser must lower costs to bring added value to the table. If we individual investors are turkeys, we seem to be the lean and diligent wild turkey admired by Ben Franklin—the kind that regularly walks through my yard this time of year, as shown in the top photo. But professional advisers would have us believe we’re the fat and lazy domesticated turkeys you find on the farm. Don’t take the bait, or you could wind up on some adviser’s Thanksgiving dinner table.
Note: Please feel free to congratulate me on resisting those enticing but overused mind-the-gap puns for the entire time it took me to write this! It was hard, but I managed to stay strong.
