My blog posts about investing are usually just so damn boring. But this time, this time, I …shoot, no, it’s just more of the same. At least this time I have research to make me sound more legit.
You might or might not have heard of Morningstar. It’s a giant, well-respected investment-research firm.
Every year they put out a fascinating (no, really?) study—called “Mind the Gap”—that compares, over the last 10 years,
- the performance of investments, aka “time-weighted” returns, versus
- what the human investors actually got out of those investments, aka “asset-weighted” or “dollar-weighted” (obviously, in the US) returns.
To spoil the ending: these are not the same. Sometimes, not by a long shot.
2020’s Mind the Gap report (free, but you have to give contact info) provides a simple example:
let’s say an investor puts $1,000 into a specific fund at the beginning of each year. That fund goes on to earn total returns of 10% the first year, 10% the second year, and negative 10% the third year, which works out to an annualized return [time weighted return] of 2.9%. But in dollar-weighted terms, the investor’s return is actually negative 0.4%, because there was less money in the account during the first two years of positive returns and more money exposed to the loss during the third year.
Historically, this study has shown, year in year out, on average, we humans get worse returns from an investment than the investments themselves return. Why is that? Mostly ‘cause we have dumb lizard brains.
I recently came across the aphorism
“Don’t change your behavior; channel it.”
And I think this study gives some good insight into how to do that when it comes to investing. Your behavior as a human (this applies to smart, stupid, professional, amateur, interested, bored investors) is instinctively wrong. No amount of will power is going to change that for most of us, so let’s pick investments that “channel” those instincts.
Morningstar draws several conclusions from this research. I found a few of particular relevance to women in tech, which I’m including below with some of my own commentary.
Own broad funds, not narrow ones.
“Broad” funds are all-in-one funds like a target-date retirement fund, or total-market funds like a total US stock market fund. “Narrow” funds could be a small-cap-value US stock fund or an energy-sector fund.
Why is this?
The more narrowly focused the investment, the more volatile it’ll be. Meaning it’ll go up a lot or down a lot. The broader the investment (i.e., the more diversified), the less volatile it’ll be.
You want to know what our entirely unhelpful lizard brains want to do when we see things going up? Buy more! You know what they want to do when we see things losing value? Sell! Otherwise known as the exact opposite of what we want to do as investors.
For example, imagine you’ve invested your money in a target-date fund. It has both stocks and bonds in it, say in a balance of 70% stocks and 30% bonds. If the stock market falls by half, then you’ve lost half of 70%, meaning you’ve lost 35% of your investment. Okay, ouchy enough. But contrast it to this:
Imagine instead that you’d invested your money into two funds: 70% of your money went into a stock fund and 30% of your money went into a bond fund. You’ll agree that’s the same position as the target-date fund above?
Now imagine the stock market falls by that same half. Do you agree that you’re still in the same total position as above? I hope so, because you are.
But we don’t tend to look at the total investment situation; we look at individual investments. So now you’re looking at that stock fund, which has lost 50% of your damn money. We don’t see that the bond fund (where 30% of our money lives) didn’t lose anything or maybe even gained something.
You’re now more likely to sell that stock fund because it hurts so much to own something that has lost half its value.
What should you do about it?
[Disclaimer: This is general commentary. I don’t know you or your financial situation so can’t give you advice on how you should manage or invest your money.]
In your 401(k), you know those target-date funds that say 2040 or 2055? Yeah, pick those. Most big tech companies have cottoned on to low-cost target-date funds and I, for one, am here for it.
When investing in general, if you have a choice between a total US stock market fund and a combination of a US small cap + US mid cap + US large cap fund, pick the total market fund. That’s going to be less volatile than any one of those three more narrowly defined funds.
The fancier you get, the worse off you’ll be.
The study showed that when it comes to US stocks and “allocation funds” (ex, target-date funds), during that 10-year period 2010-2019, investors actually did better than the investments themselves. By a very small margin, but still!
Where did investors continue to do worse than the investments themselves? Alternative funds (not just traditional stock and bond choices), specialty equity funds, and international stock funds.
Why is this?
Predictably, investor money flowed into and out of those investments at just the wrong time: money came in after the great gains had already happened, and money went out after they’d already lost money.
What should you do about it?
Don’t get fancy.
That’s pretty much my investing mantra. Choose the broadest, most inclusive funds you can. Keep in mind that
“Life is interesting. Investing shouldn’t be.”
If you feel at a loss for fun stuff to talk about with friends and colleagues, go read a book or start a hobby. Don’t change how you invest.
If you’re investing simply and broadly, then investing your money all at once is better than easing into it.
If you’ve got a bunch of money to invest, you might wonder whether you should invest it All Right Now or, juuuust in case the stock market tanks tomorrow, maybe you should invest it a bit at a time over a few months (aka, dollar-cost averaging).
The Mind the Gap study found that when you’re investing in those broadly diversified funds, you’re better off investing all your money now, in one lump sum.
And if you’re trying your hand at specialty funds, alternative funds, and international stock funds, dollar-cost averaging is better for you.
Why is this?
I can think of two reasons:
- The US stock market has done pretty much nothing but go up in the 10 years included in this study. So, getting money in sooner rather than later gave you a chance to benefit from up-ness for more time. Other markets and certain narrow slivers of the US stock market haven’t done as well.
There is no guarantee the next 10 years will be so rosy, though, historically, the US stock market does go up over time. - If you’re investing in total market funds or target date retirement funds, you’re likely the type of person who doesn’t chase trends or pay much attention to investments at all. You’re more likely to put your money in and then leave it alone.
But if you’re the kind of investor who is choosing to invest in industry-specific funds or special this or that, you’re likely more involved in investing, checking things more frequently, and therefore more likely to fall prey to the usual investment biases like buying after an investment gains in value or selling once it starts to lose value. And lump-sum investing at just the wrong time is a losing proposition.
What should you do about it?
Let me start by saying that this “lump sum vs. dollar-cost average” investing discussion is an optimization, not an essential. If you’re 35 and investing money for the long term, then getting your money invested entirely tomorrow versus smeared out over the next 12 months just isn’t going to make or break your finances over the next half freakin’ century. Just get it invested soon-ish and you’ll be good.
If you’re investing in your 401(k), you really don’t have much wiggle room. Just keep feeding the 401(k) beast steadily over each paycheck. Yes, you could “front load” your 401(k) and max it out early in the year, but then you have to worry about missing your company match and also it makes your take-home all up and down throughout the year and that hassle just isn’t worth it.
But if you have a lump sum of money because, I don’t know, you just went through an IPO, or you’ve been hoarding cash from quarterly RSU vests+sales, then think about investing that money faster rather than slower.
Does talk of investing make you fall asleep? Do you want to feel okay with talk of investing making you fall asleep? Reach out to me at . I am happy to put you on our waitlist or give you referrals to other, wonderful planners.
Sign up for Flow’s weekly-ish blog email to stay on top of my blog posts and videos.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Meg Bartelt, and all rights are reserved. Read the full Disclaimer.
