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Research Library · Study 16

The Behaviour Gap: Why Investors Earn Less Than Their Funds

  • 11 short cards
  • About 5 min to read
  • 5 quiz levels · 30 questions
  • Beginner

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Overview

The behaviour gap is the difference between what a fund earns and what its investors actually earn. It exists because people buy and sell at the wrong times. Morningstar measures it every year, and the gap is big enough to matter more than most fund fees.

Timeframe
Every year you invest
Markets
All funds and ETFs
Difficulty
Beginner

Two kinds of return

A fund’s published return assumes you invested once at the start and held until the end. Your own return depends on when you added or took out money.

If you added money after prices had already risen and sold after they’d fallen, you earned less than the fund did. Morningstar calls the fund’s figure the total return and the investors’ figure the investor return, which weights each period by how much money was in it.

Same fund, two kinds of return

What it measuresExample
Total return (the fund’s)One investment at the start, held to the end8% a year
Investor return (yours)Counts when money actually went in and out6.8% a year, if you bought late and sold early

What Morningstar found

Over the 10 years to the end of 2024, investors’ returns trailed their funds’ returns by about 1.2 percentage points a year. That’s roughly 15% of everything the funds earned, lost to timing12.

The gap varied by fund type. ETFs had a gap of about 1.7 points a year. International share funds were around 1.1 points and US share funds around 0.6. Allocation funds, such as target-date funds that hold a fixed or changing mix, had almost no gap2.

Yearly behaviour gap by fund type (10 years to end of 2024)

  • All funds1.2 points
  • ETFs1.7 points
  • International share funds1.1 points
  • US share funds0.6 points
  • Allocation fundsalmost none

Source: Morningstar’s Mind the Gap study of US funds, as quoted in this lesson.

Why it happens

People tend to pile in after a fund has done well and pull out after it has done badly. Excitement buys high, and fear sells low.

Funds that are easy to trade, or that focus on one exciting theme, invite more of this. Funds that do everything in one package, and that people usually hold through a pension or regular plan, invite less of it.

How the gap happens

  1. A fund does wellIt’s in the news
  2. People pile inBuying after the rise
  3. The fund fallsAs all funds sometimes do
  4. People pull outSelling after the fall, then missing the recovery

The catch

The study covers US funds, and the size of the gap changes from one period to another. The pattern behind it, buying after rises and selling after falls, shows up wherever people invest.

Closing the gap doesn’t need skill. It needs a plan you’ll stick to when markets are frightening or exciting.

£10,000 over 10 years: the fund’s return and a typical investor’s

£0£5,000£10,000£15,000£20,000StartYear 2Year 4Year 6Year 8Year 10
  • Fund: 8% a year
  • Investor with a 1.2-point gap: 6.8% a year

The gap costs about £2,300 over 10 years. It needs no skill to close, just a plan you stick to. Made-up returns for illustration.

Rules for closing the behaviour gap

Entry

  • Set up a regular monthly investment and automate it.
  • Prefer simple, broad funds, or a single ready-made fund, over exciting themes.
  • Write down your plan: what you hold, why, and when you’d change it.

Exit

  • Only sell for a reason you wrote down in advance, such as needing the money or reaching your goal.

Risk

  • Check your investments a few times a year, not every day.
  • When you feel a strong urge to buy or sell, wait a week before acting.
  • Keep emergency savings in cash, so you’re never forced to sell in a fall.

Worked example: same fund, different results

  1. A fund returns 8% a year over 10 years.
  2. Investor A invests £200 every month and never touches it. Their return is close to the fund’s.
  3. Investor B adds money after good years and sells after bad ones. If they lose 1.2 points a year to timing, they earn about 6.8% a year from the same fund. Over 10 years that adds up to a noticeably smaller pot.

What helps and what hurts

Strengths

  • Automatic monthly investing removes timing decisions.
  • Ready-made funds had almost no gap in the study.
  • A written plan gives you something to follow when emotions run high.

Weaknesses

  • Trading often, especially in ETFs, was linked to bigger gaps.
  • Chasing whatever did best last year usually means buying high.
  • Selling in a fall locks in losses and often misses the recovery.

Key terms

Behaviour gap
The difference between a fund’s return and its investors’ actual return.
Total return
A fund’s return assuming one investment held for the whole period.
Investor return
The return investors actually earned, taking into account when money went in and out.
Allocation fund
A fund that holds a ready-made mix of shares, bonds and other assets.
Percentage point
The plain difference between two percentages: 8% to 6.8% is 1.2 percentage points.

Lesson complete

You have reached the end of the lesson. Now test what you learned with the five-level quiz.

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Quiz zone

Test yourself: The behaviour gap: why investors earn less than their funds quiz

Five levels, from the basics to expert judgment. Clear each level to unlock the next.

  1. Level 1: Foundations. Recognise the strategy and its vocabulary.
  2. Level 2: Mechanics. Know how the signals and rules work, and why.
  3. Level 3: Application. Apply the rules to realistic chart situations.
  4. Level 4: Numbers & risk. Size, measure and manage the trade with real calculations.
  5. Level 5: Mastery. Judge edge cases, failure modes and market conditions.

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The questions only. Answers and explanations appear when you take the quiz above.

Level 1: Know the basics

  1. The behaviour gap is the difference between…

    • two different funds
    • a fund’s fee and its return
    • what a fund earns and what its investors actually earn
    • shares and bonds

  2. Which company publishes the “Mind the Gap” study?

    • S&P Dow Jones Indices
    • Morningstar
    • Vanguard
    • The FCA

  3. True or false: you can earn less than the fund you own, even if the fund does well.

    True or false?

  4. What mainly causes the gap?

    • Bad fund managers
    • Tax
    • High fees
    • Buying after rises and selling after falls

Level 2: Understand how it works

  1. Over the 10 years to the end of 2024, roughly how big was the yearly gap overall?

    • About 0.01 points
    • Nothing
    • About 1.2 percentage points
    • About 12 percentage points

  2. Which fund type had almost no gap?

    • US share funds
    • Allocation funds holding a ready-made mix
    • ETFs
    • International share funds

  3. Why might ETFs have had a bigger gap, about 1.7 points?

    • They never fall
    • They’re only for professionals
    • They charge the highest fees
    • They’re easy to trade at any time, which invites timing

  4. True or false: a fund’s published total return assumes you invested once and held throughout.

    True or false?

  5. Which kind of fund invites more buying and selling at the wrong times?

    • Cash savings
    • A broad fund bought monthly
    • A ready-made mix held in a pension
    • One focused on a single exciting theme

Level 3: Use it

  1. Markets have fallen 20% and you feel like selling everything. What helps most?

    • Sell straight away
    • Check prices every hour
    • Switch to whatever is rising
    • Follow your written plan and wait before acting

  2. Which habit is most likely to shrink your behaviour gap?

    • Following tips online
    • Checking prices daily
    • An automatic monthly investment
    • Buying after big rises

  3. True or false: keeping emergency savings in cash can help you avoid selling investments in a fall.

    True or false?

  4. A friend switches funds every few months to chase the best performer. What does the research suggest?

    • It makes no difference
    • They’ll always earn the most
    • They’re likely buying after rises, which widens their gap
    • It closes the gap

  5. How often do the rules suggest checking your investments?

    • Every hour
    • Every day
    • A few times a year
    • Never

  6. When should you sell, according to the rules?

    • After any fall
    • Only for a reason you wrote down in advance, such as needing the money
    • Whenever the news is bad
    • When a friend sells

Level 4: Work out the numbers

  1. A fund returned 8% a year. Its investors earned 6.8% a year. What is the gap, in percentage points?

    Type a number (points).

  2. A gap of 1.2 points is what percentage of an 8% total return?

    Type a number (%).

  3. On £10,000, how much is 1.2%, in pounds?

    Type a number.

  4. After 10 years, £10,000 grows to about £21,600 at 8% a year, or about £19,300 at 6.8%. How much does the gap cost, in pounds?

    Type a number.

  5. ETFs had a gap of about 1.7 points and US share funds about 0.6 points. How much bigger was the ETF gap, in points?

    Type a number (points).

  6. You invest £200 every month for a year. How much do you put in, in pounds?

    Type a number.

  7. A fund returns 7% a year. If your behaviour gap is 1.2 points, what do you earn a year, in percent?

    Type a number (%).

Level 5: Judge the evidence

  1. The study covers US funds over 10 years. What’s a fair way to use it?

    • As evidence of a common behaviour pattern, not an exact figure for you
    • As a guarantee you’ll lose exactly 1.2 points
    • As a reason never to invest
    • As proof it doesn’t apply in the UK

  2. Allocation funds had almost no gap. What’s the most likely reason?

    • They have no investors
    • People hold them steadily, often through regular pension contributions
    • They never fall
    • They’re secret

  3. True or false: closing the behaviour gap needs expert market-timing skill.

    True or false?

  4. Which claim would the study not support?

    • Trading more often always improves your returns
    • Timing can cost investors money
    • Steady investing helps
    • Simple funds can have smaller gaps

  5. The behaviour gap was about 1.2 points a year. How does that compare with a typical index fund fee?

    • It can be much bigger: many index funds charge well under 0.3% a year
    • They’re the same thing
    • It’s always smaller
    • Fees are always bigger

  6. You feel a strong urge to buy a fund that rose 40% last year. What do the rules suggest?

    • Buy straight away
    • Sell your other funds to buy it
    • Borrow to buy more
    • Wait a week before acting

  7. Why write down your plan?

    • To predict the market
    • So you have something to stick to when markets are frightening or exciting
    • It doesn’t help
    • Because brokers require it

  8. What is investor return?

    • A tax refund
    • The fee
    • The fund’s return over one year
    • The return investors actually earned, taking into account when money went in and out

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