The Investor Gap: The Hidden Cost of Chasing Returns

Scott Wimmer, CFA, CFP®
“DAVID H. BAKER Jr. has at times been called one of Wall Street's superstars. As fund manager of the 44 Wall Street Fund, he has had remarkable years in bull markets - 1971 and 1979 in particular, when the fund rose in value by 71.7 percent and 71.3 percent, respectively.
But such returns come with intense risk and fund volatility. And recently, the 51-year-old fund manager has suffered a major reversal in his fortunes. According to the Lipper Analytical Services, a New York firm that measures the performance of 739 mutual funds, Mr. Baker's 44 Wall Street Fund was the worst performing mutual fund for the fourth quarter of 1984, with a decline of 26.4 percent. And it was the worst performer for all of 1984, with a decline of 59.6 percent. By contrast, the average equity fund declined only 2 percent for the year.
Last year was obviously ''terrible,'' as Mr. Baker candidly admitted last week. But his long-term performance has also been poor because in 1981 he stayed too long with energy stocks while their prices were collapsing. And for the five-year period ending last Dec. 31, his fund was next to the bottom on the Lipper rankings, having lost 51.3 percent of its value, compared with a 99.5 percent advance by Standard & Poor's 500-stock index.”
Anise C. Wallace, New York Times – 1985

The story of the 44 Wall Street fund is a familiar one on Wall Street as investors throw their money at star fund managers in hopes of finding that elusive investor "alpha."  This practice is akin to studying those flashy signs above the Roulette tables in a casino and altering your future bets…. you’ve seen those before, right?

Casinos are masters at understanding human behavior with money. They know that by showing potential bettors the history of prior spins, they can lure players to bet larger and more often. We humans are awesome at recognizing patterns, and we love to extrapolate them into the future because we hate uncertainty. Las Vegas and Wall Street know this and use it every day to attract your investment.

What is the greatest cost for investors?  

·       Taxes
·       Fund manager fees and operating costs
·       Trading costs
·       Financial Advisor fees and commissions

These are all legitimate costs that investors can control and monitor in their portfolios but there is another cost that could very well be greater than all of these combined...

The Investor Gap:  How to turn $4.83 million into $2.92 million…

Morningstar recently released their Mind the Gap 2023 study analyzing the returns investors earned vs. the returns the funds they invested in earned; the evidence is sobering. Morningstar found that over the prior 10-year period ending 12/31/2023, investors earned roughly 1.7% less than the funds they invested in.

“As a whole (weighted by asset size), the returns investors experienced lagged reported total returns by 167 basis points per year over the trailing 10-year period, which is roughly in line with the average over the past five rolling 10-year periods.” – Morningstar Research Team

In the graphic above, investors were their own worst enemy and the greatest cost of all is from their own behavior.  Sector Equity was by far the worst asset class, showing a whopping -4.38% investor gap in returns.  Morningstar notes that this is a particularly notorious asset class known for performance chasing.  

This highlights another interesting point the researchers found; passive index investors fared worse than active fund investors.  Just because investors are moving money into a more “passive” investment vehicle does not mean that investors are being “passive" with their portfolios.  If anything, passive index ETFs provide investors with easier access to day-trading and performance chasing. Take leveraged ETFs for example, on the surface they seem like a great idea for making a strategic market bet. Most people can barely do math with fractions and percentages much less financial calculus. Below is an image showing the simple arithmetic of a leveraged ETF......good luck:

"Long Term Performance of Leveraged ETFs" - Lu, Wang, Zhang

Some Good News….

Among all fund categories, Moderate Allocation saw one of the smallest gaps highlighting the added benefit of holding a diversified portfolio of multiple asset classes within one strategy. Could it be that the simplest form of “alpha” is captured by holding a portfolio so simple that it allows the investor to ignore the wild swings in capital markets over time and remain calm???

“In 6 of the 8 category groups included in the study, funds with lower volatility (as measured by standard deviation) had narrower investor return gaps, though still mostly negative, than funds with higher volatility.”  - Morningstar Research

The CGM Focus Fund Story

You’ll notice from the graphic above how investors poured $3.6 billion of their investment capital into the CGM Focus Fund in 2007 and 2008.  Unfortunately, the returns occurred before all of the investors added their money to the portfolio. They were using the roulette sign strategy to observe past returns and extrapolate those into the future with hopes of continued outperformance.

So here we have the #1 US Stock Mutual Fund for a decade producing excess returns yet, the average investor lost money, what in the world?  Most of the cash came in following the great returns and stuck around for the losses.  

The irony is that even after it's storied rise and fall, the CGM Focus Funds has actually outperformed the S&P 500 index since its inception. Patience and conviction, two traits that are often overlooked in the search for superior performance.

I found an interesting article on this specific fund - Why Chasing Returns is a Sure Way to Lose: A Lesson From History - The Physician Philosopher.  The author of the article, Ryan Kelly, CFP, took on the task of pulling the annual SEC filings of the CGM Focus Fund and summarized that since the inception of the fund, investors had supplied roughly $12,896,259,046 into CGMFX and the fund had lost $777,526,914 of that.  Again, most of the money came in following great performance only to experience the lackluster returns that would follow the 2008-09 Great Financial Crisis.


The research clearly illustrates that chasing the “hot” fund manager or asset class is detrimental to the investors overall ending wealth.  This behavioral error could very well be the greatest cost an investor will pay overtime. Investors should ask themselves whether they “act” or “react” to the markets.  To act towards the market is to develop a strategy that is repeatable, implementable, relies on evidence, places the odds in your favor and instills conviction to hold throughout all periods.  To “react” is to simply pay attention to what everyone else is doing, what the news is shouting about, how much money your friends made trading Nvidia, etc.…  If you or your advisor are constantly altering your portfolio based on recent performance, I'd advise you to step away from the Roulette table and exit the casino; your future self will thank you for it!

"The first principle is not to fool yourself - and you are the easiest person to fool." - Richard Feynman

Disclosures: This article is for informational purposes only and should not be considered a recommendation. Information contained in this article is obtained from third party resources that Meredith Wealth Planning deems to be reliable. Consult with a financial advisor before implementing any strategies. Past performance does not equal future results. Meredith Wealth Planning does not guarantee any minimum level of investment performance or the success of any index portfolio, index, mutual fund or investment strategy.

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