The Largest Cost Facing Investors Today

Alternative Title: The Gap Everywhere  

There exist many flavors of market timing.

Some are obvious:

Others are less obvious and more sophisticated:

Overall, the average asset owner GAP from this “quick and dirty” meta-study is -3.1% per year.


Yes, there has been some criticism (here, here, here, here) of how dollar-weighted returns are calculated, and it should be addressed. Nevertheless, investors are not surprised to see these results because their personal and anecdotal experience confirms them.

To me, the most surprising is the size of the Gap in total portfolios: 28,000 endowments lag 60/40 by 5.5% per year since 2009, and multi-asset mutual fund investors lag 60/40 by 6.8% per year since 1987. Are these results representative of the average asset owner’s total portfolio Gap?

Of course, the endowment Gap is not just a product of traditional short-term market-timing (here), but poor asset allocation decisions. However, asset allocation choices can be seen as just another form of trying to time the market over longer-horizons because just like short-term market timing, its main goal is still to avoid the drawdown risk.

Traditional investment professionals often struggle with IRR measure of return used in Private Equity industry. And while IRR’s do have their challenges, when properly modified, they could make traditional investors more accountable for the bad market timing decisions. Well-performing approaches and managers typically raise record assets at the peak of their performance, and then their performance deteriorates. IRR’s would capture this asymmetry and help guard investors against the common failures of asset allocation.

I wonder how large the Gap is for allocations to emerging markets, REITs, commodities, TIPs and MLP’s? And what about Risk Parity and Factor Investing?

Investors have become significantly more aware of the negative impact of high fees on their performance and hence the huge rise in passive investing and dropping fees. The cost of taxes has also been well understood producing various advances to mitigate it (tax loss harvesting, lower turnover, retirement and college saving plans, and variable life insurance solutions).

Yet today, I believe, the dollar vs. time weighted Gap still remains as the single largest unsolved ‘cost’ facing investors. (Ideas for solutions are welcomed in the comments).

PS. thank you Mike B. Fernandez for research assistance on this blog.

PS2. See the Newton’s Gap Problem in the 1720’s during the South Sea Bubble

PS3. See John Maynard Keynes’ Gap Problem in 1920’s

Evidence & Some Criticism of the GAP:

  • Barber, Brad M. and Odean, Terrance, Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. SSRN

  • Bogle, J. C. (2007). The Little Book Of Common Sense Investing: The Only Way To Guarantee Your Fair Share of Market Returns. Hoboken, NJ: John Wiley & Sons. Amazon

  • Braverman, Oded & Kandel, Shmuel & Wohl, Avi, 2005. "The (Bad?) Timing of Mutual Fund Investors," CEPR Discussion Papers 5243, C.E.P.R. Discussion Papers.

  • Dahiya, Sandeep and Yermack, David, Investment Returns and Distribution Policies of Non-Profit Endowment Funds (December 27, 2018). European Corporate Governance Institute (ECGI) - Finance Working Paper No. 582/2018; Georgetown McDonough School of Business Research Paper No. 3291117. SSRN

  • Dichev, Ilia D., What are Stock Investors' Actual Historical Returns? Evidence from Dollar-Weighted Returns (December 2004). SSRN

  • Dichev, Ilia, D. 2007. “What Are Stock Investors’ Actual Historical Returns? Evidence from Dollar-Weighted Returns." American Economic Review, 97 (1): 386-401.

  • Dichev, Ilia D. and Yu, Gwen, Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn (July 1, 2009). Journal of Financial Economics (JFE), Forthcoming. SSRN (2010 Revision Download) or Science Direct (2011 Revision Download)

  • Faber, Nathan (2017), Misattributing Bad Behavior, Flirting with Models.

  • Friesen, Geoffrey C. and Sapp, Travis R. A., (2007) Mutual fund flows and investor returns: An empirical examination of fund investor timing ability. CBA Faculty Publications.

  • Glassman, J.K., & Hassett K.A. (1999). Dow 36,000. New York: Times Business. Amazon

  • Graham, John & Harvey, Campbell. (1997). Grading the Performance of Market-Timing Newsletters. Financial Analysts Journal - FINANC ANAL J. 53. 54-66. 10.2469/faj.v53.n6.2130. Research Gate

  • Hayley, Simon, Measuring Investors' Historical Returns: Hindsight Bias in Dollar-Weighted Returns (March 12, 2012). Midwest Finance Association 2012 Annual Meetings Paper. SSRN

  • Hsu, Jason, Myers, Brett, Whitby, Ryan, (2016) “Timing Poorly: A Guide to Generating Poor Returns While Investing in Successful Strategies”, The Journal of Portfolio Management Winter 2016

  • Keswani, Aneel and Stolin, David, Dollar-Weighted Returns to Stock Investors: A New Look at the Evidence (January 31, 2008). Available at SSRN

  • Kinnel, Russel (2018), Mind the Gap, Morningstar

  • Madhavan, Ananth and Sobczyk, Aleksander, Does Trading by ETF and Mutual Fund Investors Hurt Performance? Evidence from Time- and Dollar-Weighted Returns (April 5, 2018). SSRN

  • Odlyzko, Andrew, Newton’s financial misadventures in the South Sea Bubble, 2018, here.

  • Phalippou, Ludovic, The Hazards of Using IRR to Measure Performance: The Case of Private Equity. SSRN

  • Roberts, L. (2018). Dalbar (2017), Investors Suck At Investing & Tips For Advisors. Advisor Perspectives.

  • Samuel Crowther, "Everybody Ought to Be Rich: An Interview with John J. Raskob,» Ladies' Home Journal (August 1929). Copyright 1929, Meredith Corporation. All rights reserved. Used with permission of Ladies' Home Journal. Lincoln Public Schools