How To Save 15% More of Your Mutual Fund or ETF
Written by
Kellan Jansen
Edited by
Molly Sullivan
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If you operate like the average investor, your holdings may be returning less than you think. A Morningstar study found that investors lost about 15% of their returns over 10 years. Put differently, dollars invested in ETFs and mutual funds returned 6.3% annually, while the funds themselves returned about 7.3%.
The gap shows how the money we put into investment vehicles often underperforms them in practice. This can add up to significant lost income over the long term. But there are steps you can take to avoid this loss, as detailed below.
Manage Your Risk
Increasing risk is one strategy to improve returns. But investing in volatile stocks with high growth potential also brings more risk to your portfolio. That’s problematic when you’re trying to avoid lost gains. The data shows that investors who choose volatile stocks, mutual funds and ETFs are less likely to realize a fund’s full potential.
The reason ties into psychology. Volatile funds are more likely to experience large swings up and down. These can be difficult to hold through, which means increasing trade frequency and more fees. So, part of closing the gap is choosing investments that you would be comfortable holding in all financial conditions. Even if more volatile holdings outperform during your investment horizon, there’s no guarantee you’ll capture all of those extra gains. The data shows you probably won’t.
Embrace a Hands-Off Approach
Next, invest deliberately with a consistent strategy over time. Morningstar’s data shows that investors who follow this hands-off, buy-and-hold approach generally have smaller gaps than people who trade more frequently.
When you follow a deliberate strategy, you avoid the kind of discretionary and emotional trades that eat into long-term gains. The more frequently you trade, the more you risk missing out on some of the market’s best days.
A few poorly timed trades can be all it takes to underperform your holdings significantly. For example, data shows that if you missed the market’s 10 best days over the past 30 years, your returns would have been cut in half.
You may need to update your holdings to get comfortable with a hands-off investing approach. For example, if you have a lot of money in a volatile, thematic ETF, you may want to shift some of it to a broader-market fund that’s more stable. This could make it emotionally easier to hold through tough market conditions, as your losses would typically be lower.
Prioritize Low-Cost ETFs
You might also consider moving money out of passively managed mutual funds and into low-cost ETFs. Studies show that passive funds underperform ETF counterparts by about 42 basis points annually. The underperformance mostly stems from higher administrative fees, which can eat into your returns significantly over a long investment horizon. This doesn’t necessarily mean you need to avoid mutual funds entirely, but you should generally prioritize holdings with low fees.
For example, consider the difference between an ETF with a 1% annual fee and a mutual fund that charges 2%. Over a 15-year investment window, you could lose as much as 15% by holding the mutual fund over the ETF, depending on market performance. This illustrates the value of choosing low-cost ETFs and other holdings. Minimizing the administrative fees you pay can be all it takes to close the performance gap that costs most investors money.
Split Long- and Short-Term Accounts
Finally, consider splitting your investment accounts based on your timeline or strategy. For example, most of your money could go into a long-term retirement account where you follow a consistent, deliberate investment strategy. This would ensure you stay in the market through ups and downs with the majority of your wealth. Alongside that, you could set up a smaller account for short-term trades where you try to time market swings or invest in more aggressive, volatile assets.
Splitting your money like this lets you pursue higher returns with a small portion of your assets and without putting your long-term holdings at risk. It’s often better than keeping all of your money in one account, where you might trade emotionally with money you intended to invest deliberately. Following each of these tips can help you avoid the 15% return gap that the average investor experiences.
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