Masters in Business — “At The Money: Don’t Underperform Your Own Investments!”

Host: Barry Ritholtz, Bloomberg
Guest: Jeffrey Patak, Managing Director, Morningstar
Date: October 15, 2025

Episode Overview

This episode delves into the intriguing and often overlooked phenomenon where individual investors underperform not just market benchmarks, but even the very funds they invest in. Barry Ritholtz is joined by Jeffrey Patak of Morningstar, author of the influential “Mind the Gap” study, to understand why this persistent gap exists, how it’s measured, and most importantly, what investors can do to avoid falling into this common behavioral trap.

Key Discussion Points & Insights

1. The Investor Return “Gap” — What Is It?

• Definition: The “investor return gap” is the difference between the total return of investment funds (measured as if held passively over time) and the actual dollar-weighted returns earned by investors — i.e., accounting for the timing and size of cash flows in and out of those funds.
  • “The investor return gap is the difference between our estimate of the average return of a fund or a group of funds and that fund’s total return.”
    — Jeffrey Patak (02:52)
• Magnitude: Over the ten years ending December 2024, investors lagged fund returns by an average of 1.2 percentage points per year — costing them about 15% of aggregate total returns.
  • “The timing and magnitude of cash flows basically cost investors around 15% of their aggregate total returns.”
    — Jeffrey Patak (02:52)

2. Calculating the Gap

• The gap is calculated much like an internal rate of return, incorporating all asset inflows and outflows for funds, not just headline performance numbers.
  • “We dump all of that into a calculation that derives essentially the constant return that would reconcile the beginning assets to the ending assets.”
    — Jeffrey Patak (04:15)
• The study includes U.S. open-end mutual funds and ETFs, totaling about 26,000 funds with $25 trillion in assets.
  • “It encompasses US Open and mutual funds as well as ETFs... around $25 trillion in assets by the end of our study period.”
    — Jeffrey Patak (05:01)

3. Time-Weighted vs. Dollar-Weighted Returns

• Time-weighted returns: Assume a single lump-sum investment held throughout the period (what you see on most sites).
• Dollar-weighted returns: Reflect actual investor experience (i.e., real-life inflows/outflows).
  • “A dollar weighted return... that takes the timing and magnitude of investors purchases and sales into account.”
    — Jeffrey Patak (05:35)
• Key consequence: Chasing performance (buying highs, selling lows) erodes returns over time.

4. Behavioral Traps That Drive Underperformance

• Chasing performance: Investors pile in after strong performance (FOMO), then bail after declines.
  • “It’s sometimes chasing behavior where investors pile in... only for performance to roll over, at which point they bail out.”
    — Jeffrey Patak (06:52)
• Changing asset mixes at the wrong times: Shifting allocations in reaction to market news, not a disciplined plan.
  • “They just decided they want to be positioned differently. Only to see that wrong footed down over subsequent periods.”
    — Jeffrey Patak (07:48)

5. Where the Gap Is Largest — Types of Funds and Investor Behavior

• Sector Equity Funds: The largest gaps (~1.5 percentage points/year), with investors missing out on 20% of returns.
• ETFs: Suffer wider gaps (1.7 points/year) than mutual funds, likely due to ease of trading and market-timing attempts.
  • “ETFs had wider gaps than traditional open end funds... average dollar invested in ETFs lag the ETF’s aggregate total return by around 1.7 percentage points annually.”
    — Jeffrey Patak (08:41)
• Target Date/Allocation Funds: Almost no gap — investors successfully capture nearly all returns due to automated, “set-it-and-forget-it” characteristics.
  • “Investors in allocation funds... captured essentially all of their funds’ total returns.”
    — Jeffrey Patak (12:23)

6. Market Volatility and International Funds

• Volatility increases the likelihood of investors making impulsive trades, widening the return gap.
  • “Volatility pushes investors buttons and when it does so they tend to capture less of their funds’ total returns.”
    — Jeffrey Patak (10:48)
• International funds show slightly wider gaps than domestic funds, but both are subject to behavioral pitfalls.
  • “The gap was slightly wider for international funds... for US equity it was about half a percentage point.”
    — Jeffrey Patak (10:09)

7. Why Target Date and Retirement Funds Work

• Behavioral context: Retirement accounts discourage frequent trading.
• Automation: Regular, scheduled investments and built-in rebalancing help investors avoid emotional mistakes.
  • “They obviate the need for investors to take action to rebalance... And that has worked to investors benefit.”
    — Jeffrey Patak (12:23)

Notable Quotes & Memorable Moments

• On the perverse effect of investor timing:
  “That’s unbelievable. That’s a giant, giant shortfall.”
  — Barry Ritholtz (03:57)
• On mean reversion:
  “Yeah, mean reversion is a cruel mistress.”
  — Barry Ritholtz (08:25)
• On actionable advice:
  “It might sound a bit trite, but I would say have a plan and automate as much of it as you can.”
  — Jeffrey Patak (13:44)
• On automation:
  “Automation narrows gaps.”
  — Jeffrey Patak (14:55)
• Summary take-home:
  “Don’t let volatility distract you. Don’t try and buy or sell when markets get frothy. Don’t think you’re going to be able to time the market. And perhaps most important of all, you have to have a plan and you have to be able to keep your emotions at bay.”
  — Barry Ritholtz (14:55)

Timestamps for Key Segments

• [01:55] — Barry frames the main question: Why do investors underperform their own investments?
• [02:52] — Jeffrey Patak explains the “investor return gap” concept and gives headline results of the Morningstar study.
• [04:15] — A detailed description of how the gap is calculated and what funds are included.
• [05:22] — Breakdown of time-weighted vs. dollar-weighted returns and why the difference matters.
• [06:52] — Examples of behavioral causes of the gap: performance chasing and ill-timed asset allocation shifts.
• [08:41] — Difference in gaps between fund types (sector, ETFs vs. mutual funds, allocation/target-date funds).
• [10:09] — Comparison of international vs. domestic fund investor gaps.
• [10:48] — Discussion of the role of market volatility in widening the gap.
• [12:23] — Why target-date (retirement) funds excel at closing the gap.
• [13:33] — Practical advice for everyday investors: planning, diversification, automation.
• [14:55] — Barry’s wrap-up and summary of core lessons.

Practical Takeaways for Investors

• Have a plan: Decide on your asset allocation ahead of time and stick to it, especially in the face of market volatility.
• Automate investments: Use tools like retirement plans, target date funds, or regular automatic contributions to keep emotions out of investment decisions.
• Avoid market timing: Resist the urge to make off-schedule trades when headlines are alarming or the market gets frothy.
• Beware the allure of “hot” funds or sectors: Performance chasing has historically led to poor investor outcomes.

“Otherwise, you’re going to fall into the unfortunate fate of underperforming your own investments.”
— Barry Ritholtz (14:55)

This summary captures the main insights and actionable strategies for investors who want to avoid the common pitfall of underperforming their own portfolios — wisdom distilled from decades of investment data and behavioral analysis.