How Much Investors Pay for Market Timing

Vyacheslav Dvornikov

Dec 6, 2024

In 2015–2019, private investors on average lost 0.53 percentage points (p.p.) of annual returns due to attempts to guess when it was better to buy or sell a mutual fund, calculated a group of researchers led by Derek Horstmeyer, a finance professor at George Mason University's School of Business. For comparison: from 2020 to October 31, 2024, the average cost of loss from unsuccessful market timing was just over 1.01 p.p. per year. 

Researchers collected data on the returns of all US mutual funds denominated in dollars over the past 10 years. Then they divided them into actively managed funds and passive, index-tracking funds.

After that, they took the average value of the performance gap for each category of funds for 5 years before the pandemic and for 5 years after. The fund's performance gap is the difference between the stated annual return and the actual return of the fund (the internal rate of return, taking into account inflows and outflows, i.e., net purchases and sales). This gap reflects the difference between the average fund return and the actual return of this fund for the average investor. 

This gap arises because the stated return of a mutual fund reflects the average return of its assets over a certain period. But since investors are generally weak in market timing (panic selling when the market declines and investing more when the market is at its peak), they often do not fully achieve the stated return. In other words, this performance gap reflects how inefficiently investors trade their mutual funds.

It turned out that in actively managed funds, the performance gap is larger. For these funds, it increased more since the start of the pandemic. Researchers explain the growth of losses from market timing by the fact that locked-down private investors became more active, and internet forums like WallStreetBets on Reddit encouraged vigorous trading.

Why it matters

Investors who want to frequently use market timing should be prepared for their returns to be lower than expected.