Do you own mutual funds? If you do, how did you choose them?

No matter what the fine print says (“Past performance is no guarantee of future results”), surely you looked at historic returns to make your decision.

What many don’t realize is those yearly returns are easy to fudge.

To bring this idea to life, take a look at the following example (summarized in Table 1). Let’s say you invest $1,000 in a mutual fund:

After Year 1, the fund enjoys an amazing 100% return; your money doubles and now you have $2,000.

During Year 2, the fund suffers a 50% loss; you lose half your money and now you have $1,000.

During Year 3, the fund goes back up by 100%; your money doubles and now you have $2,000.

Year 4 sees another bear market and the fund tumbles 50%. Your money takes a 50% haircut and you are back to $1,000.

Table 1

YEAR % RETURN $ RETURN
1 + 100 $2,000
2 – 50 $1,000
3 + 100 $2,000
4 – 50 $1,000

After four years, the financial advisors at the mutual fund assess how the fund did. The math is simple:

100% + 50% + 100% + 50% = 100% / 4 Years = 25%

The total average return is 25% per year. Yet, in spite of that lofty return, the bottom line is that you made zero profit in four years.

Now do you see how total returns can be fudged?

Reality can be even worse. Two other factors come into consideration: taxes and fees:

  • In a taxable account, you will pay taxes profitable years. In this example, you will pay capital gains taxes after Years 1 and 3.
  • Regardless of whether you make money or not, the mutual fund company will charge fees.

Take a look at how this example changes with taxes and fees taken into consideration  (summarized in Table 2):

Let’s say you pay 30% in taxes and 1% in fees. You start with $1,000 and your returns stay the same over four years:

In Year 1:

  • 100% Profit = $2,000
  • 1% Fees = $20 ($1,000-$20 = $980)
  • 30% Taxes = $294 ($980* .30)
  • Total: $1,686

In Year 2:

  • 50% Loss = $843
  • 1% Fees= $8
  • No taxes (not a profitable year)
  • Total: $835

In Year 3:

  • 100% Profit = $1,670
  • 1% Fees= $17
  • 30% Taxes= $245
  • Total: $1,408

In Year 4:

  • 50% Loss= $704
  • 1% Fees= $7
  • No taxes (not a profitable year)
  • Total: $697

In summary, you invested $1,000 and wound up with only $697 after four years.

Table 2

YEAR % RETURN 1% FEE 30% TAX RATE $ AMOUNT
1 + 100 -$20 -$294 $1,686
2 – 50 -$8 $835
3 + 100 -$17 -$245 $1,408
4 – 50 -$7 $697

What’s more, your mutual fund company can legitimately claim 25% per year return after four years, meaning your results are actually around -8%  per year!

Now, take inflation into consideration and returns are even lower…

Trying to predict future returns is a fool’s errand. The best investors in the world spend their lives designing the models to predict the future, yet there are infinite uncontrollable and unpredictable factors.

Smart Asset Opportunities takes an entirely alternative approach based on investing in tangible assets. We invest in such a way that our returns are as safe and predictable as humanly possible.

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The Truth About Mutual Fund Returns
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Do you own mutual funds? If you do, how did you choose them? Read more to learn about the truth about mutual fund returns.
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