Why do investors earn less than the funds they own?
Here is a fact that sounds like a mistake: a fund can report a positive return for a period in which the average euro invested in it lost money. Both numbers are correct. They measure different things, and the distance between them is the most honest scorecard in personal investing.
Two returns, one fund
The number on the factsheet is the time-weighted return — what one euro would have earned by sitting in the fund from the first day to the last, ignoring when other people's money arrived or left. It measures the manager.
The number that lands in real accounts is the money-weighted return (also called dollar-weighted, or the internal rate of return). It weights each period by how much money was actually present. It measures the investors.
The distance between them is the behaviour gap.
Watch it open up
A small fund, two years.
- It starts with €100 from one early investor. Year 1 returns +50% → €150. Excellent performance, widely noticed.
- At the start of year 2, €900 of new money arrives, attracted by that record. The fund now holds €1,050.
- Year 2 returns −20% → €840.
Now score it both ways.
- Fund return (time-weighted): 1.50 × 0.80 = 1.20. The fund is up 20% over two years — about +9.5% a year. Entirely true. It goes on the factsheet.
- Investor return (money-weighted): €1,000 went in, €840 is left. Investors, collectively, are down 16% on the money they contributed — and because most of that money was present for only the losing year, the annualised internal rate of return that solves 100(1+r)² + 900(1+r) = 840 comes out at about −14.7% a year.
A fund up 20% over two years whose investors ended 16% below what they put in. No fraud, no hidden fee, no error. The gap was created by when the money arrived — and the money arrived, as it usually does, after the good year.
How big is it in the real world?
Smaller than you have been told, and less settled than anyone quoting it admits.
The figure most often repeated — investor returns trailing fund returns by roughly one to two percentage points a year — comes from a family of flow-weighted studies, and the most-quoted of them has since been re-examined in the peer-reviewed literature using the same underlying data. That re-examination found several errors in how the gap had been constructed. The largest was a timing convention: cash flows were weighted as though they arrived at the end of each month rather than the beginning, which in a rising market credits new money with returns it was never present for and inflates the measured gap. Corrected, the cost of investor timing came out at roughly a tenth of a percentage point a year — an order of magnitude below the familiar range.
So treat the size as an open question, and treat any source quoting it to the decimal with suspicion. What survives the argument is the direction: across studies, countries and decades, money tends to arrive after the good stretch and leave after the bad one, and that pattern costs something rather than nothing. The mechanism you just watched in the two-year fund is not in dispute. Only its magnitude in the wild is.
The disputed upper end is still worth pricing, because that is what decides whether this deserves your attention at all. Take a 1.5-point gap on €100,000 over 30 years:
- At 7%: about €761,000.
- At 5.5%: about €498,000.
About €263,000 — roughly a third of the outcome. Read that as a sensitivity, not a measurement: it is what the gap would cost if the higher estimates are right. Run the same arithmetic at a tenth of a point and the cost is about €21,000 — small beside €761,000, and still worth having. And here is the part worth sitting with at either end of the range: nobody invoices you for it. Fees appear on a statement and can be shopped around. The behaviour gap appears nowhere. It is the price of your own timing, paid silently.
Committees do it with managers. Goyal and Wahal (Journal of Finance, 2008) studied roughly 8,700 hiring decisions and about 870 terminations by US plan sponsors between 1994 and 2003. Managers were hired after about three years of large positive excess returns and earned roughly zero excess return in the three years after hiring; managers fired for performance went on to beat their replacements. The mechanism is the two-year fund above with a committee minute in place of a brokerage statement, and the performance course's last unit says why a three-year record cannot bear that weight. A fiduciary's written policy fixes the grounds for termination in advance; a shortfall inside the mandate's noise is not one of them.
The good news hidden in the bad
A gap caused by your decisions is, uniquely among your problems, entirely yours to close. You cannot make markets calmer, cheapen fees below zero, or acquire skill on demand. You can stop adding money after the good year and stop removing it after the bad one — and unlike every other improvement available to a portfolio, that one costs nothing to make.
Measure it before you fix it. If your platform reports both a time-weighted and a money-weighted (IRR) return, the difference between them is your personal gap, in your currency, on your capital.
Try it now
- Find both return figures for your own account — most brokers report a time-weighted return and an IRR or money-weighted return. Write down the difference. That is your gap.
- List every contribution and withdrawal you made in the last three years alongside what the market had just done. Look for the pattern: did money arrive after strength and leave after weakness?
- Reconstruct the lesson's example on the chart below. Measure a two-year stretch to get the market's own return, then lay your own contribution dates over it and ask when your money was actually invested. The path is on this page; the timing half is not, and never will be — it is not market data. Seeing your own entry is more persuasive than any study.