Attempting to time the market costs UK investors 7% of their annual returns

The appetite for greater returns leads many investors to try to time the market, but according to research from Morningstar, this strategy actually costs them profits.

To measure investors’ timing, the data firm compared total returns between the start and end of a period earned with a buy-and-hold approach, with the “investor” return, which tracks asset flows into a fund during the calculation period to give the return of investors trying to time their entry point.

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Looking back over a five-year period, Morningstar found that UK investors were 7% worse off if they attempted to time the market instead of using a buy-and-hold approach.

UK-domiciled funds delivered an average annualised return of 4.46% over the past five years, but the “investor” return was 4.14% a year. While this is a 0.32% percentage point difference, the gap as a percentage of total returns is 7%.

The research considered funds in six different regions, including Ireland and Luxembourg, and found that all investors would have been better off with a buy-and-hold approach.

Human behavioural biases are to blame for the poor returns for investors who try and time the market.

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Morningstar notes that investors tend to follow the herd when markets rise and buy funds that have recently performed well but may be overvalued, meaning that they miss the best returns. In contrast, investors avoid poor-performing funds that may be due a turnaround.

Matias Möttölä, director of manager research, Morningstar, said: “Markets have been difficult to navigate in recent years. At times, markets have been exuberant, tempting investors to chase returns in areas such as technology stocks, while events such as the onslaught of the Covid-19 pandemic and the Russia-Ukraine war led many to flee their funds in fear of losses.

“Our study shows that often investors would have done best by staying with their investments rather than attempting to time the markets in search of big gains from gimmicky funds. Less volatile and simpler funds yielded better end results.”

Morningstar warned that niche investment funds, which may track a single sector or country and can therefore be very volatile, were the most prone to poor investor behaviour.

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Morningstar says that the money that poured into the iShares Global Clean Energy Ucits ETF was a classic example of poor investor timing.

During 2020, the fund doubled in size and delivered a 140% return. The exchange-traded fund (ETF) then went through two years of losses and stopped attracting assets.

As a result, while total returns showed the fund performing 17% annualised over the 2018-23 period, the estimated investor return was negative 3% a year, as most investors entered the fund only after its strong returns, just in time to experience the subsequent underperformance.

Other dangerous fund sectors for DIY investors were China and India equity funds.

On the other hand, Morningstar found that investors timed their entry into fossil fuel energy funds well, with the most monthly flows in BGF World Energy coming in April 2020, before the fund nearly doubled in size on the back of higher resource prices throughout 2020.