A new report confirms, once again, an old bit of wisdom: The smartest investment for most people across the globe are low-cost, low-volatility index funds.
That's according to investment research firm Morningstar's 2019 "Mind the Gap" report, a biennial global study of investor returns. Morningstar found that individual investor returns are lower, overall, than the returns for the mutual funds and ETFs that they are investing in. The "gap" in the report's headline refers to the gap between how any fund performs and how people invested in that fund fare. Returns had the worst performance in the most volatile markets.
That indicates that people are withdrawing their money from the stock market at inopportune times, or when the market is dropping, according to Morningstar. If investors left their money alone, as experts advise, during times of stock market turbulence, you would not expect a "gap" compared to the total returns for a fund that they are invested in.
Individuals fared better when they were invested in low-cost, low-volatility funds, Russel Kinnel, chair of Morningstar's North America ratings committee, noted in a press release. The report also found that those making automatic contributions to their investments — say, by contributing a percentage of every paycheck — were the most successful.
"Investors should continue to prioritize low-cost and less-volatile funds, and steady investments that can stand the test of time," says Kinnel.
The good news: The gap between a fund's performance and its investors' performance is shrinking. Before 2017, the gap was more than three times as big. Investors might be learning a thing or two.
Investing in low-cost index funds, which cover broad swaths of the stock market (therefore making them more diverse and less volatile), is the strategy most commonly advised by financial experts for individual investors. Even Warren Buffett, the billionaire founder of Berkshire Hathaway, advises people to stick to index funds over stock picking or other types of investing.
"Costs really matter in investments," Buffett told CNBC in 2017. "If returns are going to be seven or 8% and you're paying 1% for fees, that makes an enormous difference in how much money you're going to have in retirement."
Funds that passively track the S&P 500 or another index can have expense ratios — the cost you pay the broker to invest — as low as tenths of a percent. The average expense ratio of passive funds was 0.15% in 2018, according to Morningstar. The original index fund, the Vanguard 500, has an expense ratio of just 0.04%. Some brokerages, like Fidelity, among others, have even started to offer no-cost index funds.
That's good for everyday investors because a higher expense ratio, even something as seemingly small as 1%, can eat away at returns.
As Morningstar's report notes, the low-cost funds are only effective if you continuously invest in them and don't try to time the market, or pull money out when it starts to drop. Doing so will hurt your returns, and you'll miss out from any potential rebound in the market. The S&P 500 had 17.8% 10-year annualized total since it bottomed out in March 2009, which matched the gains made by the S&P following the downturns in 1982 and 1987.
Update: This article has been updated to reflect that Schwab does not offer fee-free funds.
Like this story? Like CNBC Make It on Facebook!