investing

Your Real Total Return

Why there is often a gap between reported and actual investor returns.

While reading your favorite financial magazine (presumably this one), you note that the hot Russia fund into which you sank $10,000 six months ago gained 35% over the past year.

You smugly compliment yourself for your investing brilliance. But a few days later, your fund statement arrives and you're shocked to discover that your stake is now worth only $9,000. What happened? you wonder.

What happened in this hypothetical, but far from far-fetched, example is that the fund achieved all of its past-year's gains before you bought it and sank after you invested. One plausible scenario: The fund may have rocketed 50% in the first six months of this hypothetical 12-month period, lured you in, then lost 10% the next six months -- hence, a one-year return of 35% but a 10% loss for you.

The difference between a fund's published returns and what investors actually earn is the subject of important new data from Morningstar. The fund rater looks at dollar-weighted returns, or how much money the average dollar invested in a fund earns over time. These "investor returns" take into account a common error that too many of us make: buying funds when they're hot and selling them when performance drags.

Morningstar's figures underscore the emotional dangers of investing in high-octane funds. Over the past ten years to November 1, investors in the most volatile 25% of mutual funds earned, on average, only two-thirds of the funds' average reported total returns (see the table for some specific cases). "Volatile funds inspire fear and greed and make people handle their money poorly," says Russ Kinnel, Morningstar's director of fund research. "They buy after the fund has made a lot of money and sell after it has lost money."

In contrast, investors in more-stable funds -- value-oriented and low-turnover funds often fit the bill -- earned virtually the same amount as their funds' stated returns over long periods. "The more boring funds rarely have those emotional tripwires," says Kinnel. "Investors tend not to get thrown for a loop with stodgy funds."

The message is clear: Pay attention to volatility, a good proxy for risk. Before you buy a volatile fund, make sure you have the constitution to withstand the inevitable spills. Better yet, make sure those rockets are part of a well-diversified portfolio. That way, your investment program isn't at the mercy of one fund's possible collapse.

Returns: You vs. the fund

Investor earnings are often far less than funds' reported gains, particularly with volatile funds.

VOLATILE FUNDSSYMBOL5-YR ANNUALIZED FUND RETURN5-YR ANNUALIZED INVESTOR RETURN
Alpine U.S. Real Estate EqEUEYX25.5%8.4%
CGM FocusCGMFX23.414.3
Hodges FundHDPMX21.911.8
Royce Value ServiceRYVFX19.33.1
U.S. Global Investors Glbl ResPSPFX40.121.9
SEDATE FUNDSSYMBOL5-YR ANNUALIZED FUND RETURN5-YR ANNUALIZED INVESTOR RETURN
Fidelity PuritanFPURX8.2%8.1%
Jensen PortfolioJENSX5.75.3
Osterweis FundOSTFX10.910.6
Selected American Shares SSLASX9.79.7
Third Avenue ValueTAVFX15.615.0

Data through September 30. Source: Morningstar

Most Popular

What Are the Income Tax Brackets for 2022 vs. 2021?
tax brackets

What Are the Income Tax Brackets for 2022 vs. 2021?

Depending on your taxable income, you can end up in one of seven different federal income tax brackets – each with its own marginal tax rate.
September 20, 2022
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
What Is the Social Security COLA?
retirement

What Is the Social Security COLA?

Consumer prices have spiked this year, meaning a higher Social Security cost-of-living adjustment for 2023.
September 16, 2022

Recommended

Who leads in which states before election day?
Economic Forecasts

Who leads in which states before election day?

In a tight race, these state elections may make the difference when midterm results are announced in November.
September 22, 2022
Capital Gains Tax 101: Basic Rules Investors and Others Need to Know
capital gains tax

Capital Gains Tax 101: Basic Rules Investors and Others Need to Know

Learn the ins and outs of the capital gains tax, which you may owe if you sell stocks, your home, cryptocurrency, a stamp collection, and much more.
September 22, 2022
Recession or Not? We Could Be in the Eye of the Storm
investing

Recession or Not? We Could Be in the Eye of the Storm

Our economy is showing one major sign we’re in a recession, but there are at least seven other red flags currently waving. It’s tough to ignore a thre…
September 19, 2022
Why a Target-Date Fund Works for Me
investing

Why a Target-Date Fund Works for Me

Target-date funds are attractive for their simplicity. And while I've invested in one in the past, that doesn't mean it's the right choice for you.
September 16, 2022