Investors underperform the funds they own
The claim
The return the average investor earns is measurably lower than the return of the funds they hold, because of when they buy and sell.
Why we rate it strong
Documented in brokerage account records covering tens of thousands of households, and independently in fund flow data updated annually.
Barber and Odean obtained the trading records of tens of thousands of households at a discount broker. Households that traded most earned dramatically less than households that traded least, and the gap was far too large to be explained by anything other than the trading itself. Gross of costs, the stocks these investors sold went on to outperform the stocks they bought. They were not merely paying to trade — they were paying to trade in the wrong direction.
The same pattern appears from a completely different data source. Comparing a fund's published time-weighted return to the money-weighted return its investors actually earned reveals a persistent shortfall, because money arrives after good performance and leaves after bad. The measured gap is typically around a percentage point a year — smaller than the brokerage account studies, but drawn from the whole market rather than the self-selected group who open trading accounts.
This is why our decision simulator hides the year. The point is not to test whether you can call markets. It is to let you observe your own reactions to a drawdown you cannot date, and then price them.
Where this breaks down
- The size of the gap varies by fund type. It is widest in volatile, narrow, high-attention funds and close to zero in broad allocation funds that people simply hold.
- Some of the gap is not a mistake. Selling to buy a house or fund a redundancy is a rational cash flow, not a behavioural error, and the data cannot always tell the two apart.
- The brokerage studies predate zero-commission trading and cover a self-selected group of active traders; the direction of the finding has held up, the magnitude is specific to that sample.
Sources
Follow these rather than taking our word for the summary.
Brad M. Barber and Terrance Odean (2000). Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors
The Journal of Finance, 55(2), 773-806
Finding: Households that traded most frequently substantially underperformed both the market and households that traded least.
Terrance Odean (1998). Are Investors Reluctant to Realize Their Losses?
The Journal of Finance, 53(5), 1775-1798
Finding: Investors sell winners and hold losers — the disposition effect — which lowers returns even before tax is considered.
Morningstar (2024). Mind the Gap: Investor Returns vs. Fund Returns
Morningstar Research, published annually
Finding: Investor money-weighted returns lag the funds' own reported returns by roughly one percentage point a year over rolling ten-year periods.