Mind The Gap
We have friends who have lived in London for the past few years, and we have enjoyed visiting them over the last few years. While there, we took the London Underground frequently, and our kids found the announcements to “mind the gap” entertaining.
A very little Ethan and Ben at their first Tube stop
Me and my friend, successfully having minded the gap…
The phrase “mind the gap” was created around 1968 for an automated announcement on the London Underground, replacing manual warnings from staff. Because digital storage was limited and costly, the message had to be brief and easy to display on platforms. Its simplicity made it both practical and enduring. Today, “mind the gap” is often used metaphorically to mean being aware of differences or gaps—such as in knowledge, expectations, or communication.
In investing, it is particularly important to mind gaps in expectations, knowledge, and behavior because of the potentially outsized impact on returns. Every year, Morningstar does a study (called “Mind the Gap”) that explores the gap between the reported returns of mutual funds with the average actual returns earned by investors.
The 2025 study offers a sobering yet hopeful reminder: investors often earn less than their funds do. Over the 10 years ending December 31, 2024, the average U.S. mutual fund or ETF returned 8.2% annually, while the average investor in those funds earned only 7.0%.
That 1.2-percentage-point difference—what Morningstar calls the “investor return gap”—may sound small, but over a decade it compounds into roughly 15% less total return.
The cause? It isn’t poor stock selection or fund management—it’s timing. The more investors traded, the less they made. By chasing performance and reacting to market swings, investors inadvertently bought high and sold low. In other words, behavior—not markets—often stands between us and our financial goals.
Morningstar’s research found several consistent patterns:
Higher trading activity widened the gap. Investors in funds with more-volatile cash flows—those buying and selling more often—earned significantly lower returns than those in more stable funds.
Complex or niche funds saw larger gaps. Sector-specific and high-tracking-error funds tested investors’ patience and conviction, leading to mistimed trades.
All-in-one, steady strategies performed better. Investors using allocation or target-date funds captured nearly all of their funds’ total returns, thanks to built-in diversification and automated rebalancing.
In short, investors who made fewer decisions often made better ones. Staying put—particularly through turbulence—proved far more rewarding than trying to outsmart the market.
The gap is not a moral failing—it’s human nature. We feel compelled to act when markets rise or fall sharply. But that instinct, while understandable, is often costly. As Morningstar notes, “the more investors traded, the less their average dollar made.”
Investor and writer, Howard Marks writes about choices that investors make in a recent memo called The Calculus of Value.
(Side note…Howard Marks is a well-regarded investment manager who gained prominence through his widely read memos to investors, where he shares insights on market cycles, risk, and investment psychology. Warren Buffett has said, “When I see memos from Howard Marks in my mail, they’re the first thing I open and read.” We highly recommend his memos for the intellectually curious…they are well worth the read!)
Regarding what actions investors should take in regard to the historic market highs in the market and expensive stock valuations, Marks writes:
What should you do about it? I consider tactical actions in terms of the spectrum that runs from aggressiveness to defensiveness, and when valuations are high, I consider becoming more defensive. In the “action shows” my wife, Nancy, and I like to watch, the Pentagon sometimes announces a Defense Readiness Condition, starting at DEFCON 5 and escalating as the danger grows to DEFCON 1, which indicates a nuclear attack is underway or imminent. In a similar vein, I think of progressively applying the following Investment Readiness Conditions, or INVESTCONs, in the face of above average market valuations and optimistic investor behavior:
- Stop buying
- Reduce aggressive holdings and increase defensive holdings
- Sell off the remaining aggressive holdings
- Trim defensive holdings as well
- Eliminate all holdings
- Go short
In my view, it’s essentially impossible to reasonably reach the degree of certainty needed to implement INVESTCON 3, 2, or 1. Because “overvaluation” is never synonymous with “sure to go down soon,” it’s rarely wise to go to those extremes. I know I never have. But I have no problem thinking it’s time for INVESTCON 5. And if you lighten up on things that appear historically expensive and switch into things that appear safer, there may be relatively little to lose from the market continuing to grind higher for a while… or anyway not enough to lose sleep over.
While it’s reasonable to be cautious when markets look “worrisome,” it’s rarely wise to trade in large swings or abandon the market entirely. The discipline of remaining invested—perhaps with a more defensive tilt, but still in the game—is key to long-term success.
Patience, not prediction, remains the greatest edge an investor can hold. The Mind the Gap study makes it clear: the markets will reward those who let time and discipline do their work. By resisting the urge to react—and instead anchoring to a thoughtful, long-term plan—we not only limit the return gap, we also gain something equally valuable: peace of mind.