(PUB) Investing 2015

Mind the Gap 2015: Better Results for Investors Continued From Cover

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but not most muni funds. The upshot was that muni- fund investors have sold just before a strong rally twice in the past five years. Drilling Down to Categories One type of fund stands out as a great match of investor and fund: target-date funds. Across the board, target-date funds have positive return gaps, meaning that investors are making the most out of those funds. The fact that the funds are almost exclusively held in 401 (k)s is the most important element. Clearly, the discipline of investing more from every paycheck works wonders. When you see funds with the worst return gaps, they are usually highly volatile ones that inspire attempts at market-timing. The evidence shows we do far better when we ignore the headlines and stick to our plans. That brings me to some of the biggest return gaps: regional stock funds. The four worst are India, diversi- fied Pacific/Asia, Europe, and Japan. These are all fine places to invest, but they inspire people to make bold macroeconomic calls that tend to go poorly. It’s worth remembering that the link between economic growth and markets is surprisingly tenuous. Also, buying after good economic news will often lead you to overpriced securities just as buying after a good earnings report will. A Bright Line on Risk What happens if you separate funds based on Morn- ingstar Risk? It turns out the impact is dramatic.

The lowest-risk quartile has a 6 . 56% 10 -year annual- ized return versus a 5 . 3% average return, making for a positive return gap of 126 basis points. The second- lowest-risk quartile dipped to a still respectable 5 . 88% return and a gap of 4 basis points. The third- lowest-risk quartile had a 5 . 63% average investor return, making for a 32 basis point gap. Finally, the highest-risk quartile of funds had an average invest- or return of 4 . 53% —that’s more than 200 basis points worse than the lowest-risk quartile—and it had a gap of 132 basis points. The Impact of Fees I spliced investor returns by expense-ratio quartile and found some interesting results. Not only did investing in the cheapest quartile deliver better investor returns, but it also led to a smaller gap. So that means investors in cheap funds chose higher- returning funds and used them better than those in higher-cost funds. For example, the 10 -year U.S. equity return for the average investor was 6 . 92% , with a gap of 119 basis points. However, investors in the priciest quartile had a meager 3 . 71% return on average and a huge gap of 299 basis points. Overall, the average investor return across all funds was 5 . 61% for the cheapest quintile and 3 . 28% for the priciest. The gap was 80 basis points for the cheapest quintile and 179 basis points for the priciest. Funds With High Investor Returns Which funds had the highest investor returns in abso- lute terms? It was largely those with highest total returns. T. Rowe Price Health Sciences PRHSX , Fidelity Select Health Care FSPHX , T. Rowe Price Media & Telecommunications PRMTX , T. Rowe Price Global Technology PRGTX , and Primecap Odyssey Aggressive Growth POAGX led the way. But perhaps more informative is the list of those with top-percentile investor returns for their category. In all, nine Morningstar 500 funds landed in the top percentile of their peers, and most had less volati- lity than their peers. Also noteworthy was the consis- tency of their returns. These nine tended to consis-

Asset-Weighted and Average Total and Investor Returns—Trailing Through 12/31/2014

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p Average 10-Yr Total Return (%) p Asset-Weighted 10-Yr Investor Return (%) p Returns Gap (%)

9

7.47 6.49

7.16 7.18

-0.98

0.02

5.74 4.55

6

5.42 5.40

5.75 5.21

4.44 3.75

-1.19

-0.02

3.66

-0.54

-0.69

3

2.36

-1.30

0

U.S. Equity

Sector Equity

Allocation

Intl Equity

Taxable Bond

Municipal Bond

All Funds