Young & Invested: Are you sabotaging your ETF returns?
ETFs have made investing easier than ever. But our latest study shows that many investors are still finding ways to underperform their own investments.
Welcome to my column, Young & Invested, where I discuss personal finance and investing for Gen Z and Millennials.
This column aims to be a resource for young investors navigating an ever changing financial, political and social landscape as they try to build wealth. Tune in every Thursday for the latest edition.
Edition 75
My morning commute to work is relatively painless.
Pick up coffee (instead of saving for a house deposit) and then 10 minutes of semi-conscious wandering to the bus, usually soundtracked by whatever slop Spotify’s algorithm comes up with.
One activity I refuse to do, is check how my investment portfolio performed yesterday. Mostly because I prefer to arrive at work in a reasonable mood.
Still, I understand the urge. As retail investors, we divert the majority of our focus on scanning for external factors that may derail our outcomes. Inflation, rate hikes and everyone’s favourite new phrase ‘geopolitical tensions’. Then of course we can’t forget the LinkedIn post from someone who has apparently predicted all 17 of the last three market crashes.
The irony is that the biggest threat to our returns is often sitting on the other side of the screen. Morningstar’s annual ‘Mind the Gap’ study compares the difference between overall fund return and the return that investors actually receive.
The most recent iteration of the report revealed that the average investor dollar in US stock funds and ETFs earned 8.7% per year over the 10 years ended Dec. 31, 2025. On the other hand, the funds themselves delivered an aggregate annual return of 9.9% a year. The 1.2% shortfall is attributable to investor decisions around the timing of purchases and sales.
The ETF paradox
One of the great strengths of ETFs is their accessibility. A few taps on my phone and I can own half the ASX before my 10am soy latte goes cold. I can also sell my ETF almost instantly if things take a turn. This accessibility has been transformative for younger investors as the rise of low-cost brokerage platforms and investment apps continue to lower the barriers of entry to wealth.
But this flexibility is not without a catch. Many investors have developed the habit of checking portfolios with the frequency previously reserved for Instagram notifications. This constant access can create a false sense that action is almost mandatory.
When the ASX falls 5%, I don’t need to call my broker, complete paperwork or wait until the end of the trading day to make a change. The consequence is that while many investors intellectually understand long-term investing, they still behave like short-term traders. And as our study shows, there is a cost to this mismatch.
Despite ETFs delivering stronger overall returns than traditional open-end funds over the decade to December 2025, ETF investors experienced wider timing gaps across almost every major asset class.The gap between what ETFs returned and what investors actually earned was 1.6% per year, compared to 1.2% for traditional funds.
A return gap of 1.6% per year doesn’t appear dramatic, however investing is a game of compounding. A seemingly small annual shortfall, repeating itself over decades can translate into a materially smaller portfolio at retirement.
This also means the market can perform exceptionally well while investors still underperform it. Attempting to tactically time your investments through adding money after strong rallies, trimming positions after market declines or switching between successful investment themes can all reduce the likelihood of capturing the full return of an investment.
This is particularly relevant as ETFs are increasingly being used (and offered) not just as diversified portfolio building blocks, but as vehicles for expressing short-term views. Investors can use an ETF to gain exposure to everything from broad global markets to highly niche sectors and investment themes. The narrower and more specialised a strategy becomes, the more volatility investors typically have to stomach and the greater the temptation to trade at the wrong time.
Active vs passive
Passive investing has increasingly become synonymous with ‘safe’ investing. Lower fees and market-matching returns have made it the preferred approach for many investors. That is why one of the more surprising findings from the study was that the ‘safe’ approach didn’t miraculously eliminate behavioural mistakes.
Index fund investors earned 10.3% annually over the decade studied, outperforming active fund investors who earned 7.5%. Yet passive investors still captured less than the full return generated by their funds, producing an investor return gap of 1.1%. In other words, it is entirely possible for investors to sabotage a vanilla index fund.
Passive investing solves many problems, but not all of them. The study found little evidence that active versus passive management was the key driver of investor return gaps. Instead, the more important factors appeared to be how investors accessed investments and how they chose to use them.
Ironically, the implication here is that being a successful investor is often less about finding the perfect investment vehicle and more about maintaining a consistent approach regardless of prevailing market conditions.
The role of volatility
Another interesting section examined the relationship between fund volatility and investor behaviour.
To almost no one’s surprise, the more volatile a fund was, the larger the investor return gap tended to become. The least volatile funds returned investors 11.2% annually, compared with a total return of 11.6%. On the other hand, the most volatile funds generated lower returns overall and significantly wider gaps.
This is particularly relevant in today’s ETF landscape, where investors can gain exposure to almost any theme imaginable, whether that’s AI, uranium or defence. However, narrower strategies tend to be more volatile by nature. They often experience stronger rallies, sharper drawdowns and greater periods of uncertainty than broad market funds. This volatility manifests in the behavioural challenge of holding these investments successfully.
None of this constitutes an argument to avoid the most volatile funds. If you’ve chosen to allocate part of your portfolio to a narrower strategy, it helps to know in advance what you should be prepared for and how it may affect your overall return.
Concluding thoughts
The biggest threat to your portfolio and ultimately your financial outcomes has rarely been the market noise we devote so much attention to. More often than not, it’s our own reaction to those events.
The Mind the Gap study shows that investors consistently leave returns on the table for a number of factors. In the case of ETFs, the irony is that many of the same features that make them effective investment vehicles can also make them easier to misuse. But I think the encouraging part of this is that this problem is fixable.
The investors most likely to have lower return gaps aren’t necessarily those with the best market forecasts. Instead, the data shows they tend to be the ones making fewer discretionary decisions in the first place.
