"I'm sure glad I took the time to read through this site. I had no idea what my advisor was doing to me." - Bill M.
Quotes
Evaluating Your Returns
"The miracle of compounding returns is overwhelmed by the tyranny of compounding costs" - John C Bogle, Founder, Vanguard
"Many receive advice, few profit by it." - Publilius Syrus, 42 BC
"We study broker-sold and direct-sold funds from 1996 to 2004, and fail to find that brokers deliver substantial tangible benefits." - "Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry"
"A vast industry of stockbrokers, financial planners, and investment advisers skims a fortune for themselves off the top in exchange for passing their clients' money on to people who, as a whole, cannot possibly outperform the market." - Michael Lewis
Welcome to 'Evaluating Your Returns'!!
Before we start, there are a few things that are important to understand. We will be looking at your PAST returns. No one, and I mean no one, knows what your FUTURE returns will be. I don't, your financial advisor doesn't and Warren Buffett doesn't. Run from anyone that tells you they do know and promises you that they can get you great returns. Or, ask them to put that it writing, sign it, and watch them run.
Based on the above, think about why it's not a good idea to pay a lot of money in fund fees: Since no one can tell which few higher priced funds might do well in the future, you might as well not pay a lot of money to own high priced funds. Instead, own low cost funds that don’t have the hurdle of high expenses to overcome. If a fund charges 2% in fees, it has to do 1.80% better than a fund that costs .20%.
So why are we looking at past returns? Three reasons. One, so you can see how volatile your funds have been in the past and, two, so you can learn how to compare your fund returns to their proper benchmark and, three, so you can see that paying more probably doesn't give you better returns. The longer the timeframe, the fewer high cost funds outperform low-cost index funds. Even if some high cost funds have done well in the past, the high fees make it unlikely for this performance to continue ongoing.
So what does 'comparing to the proper benchmark' mean? It means that you need to compare apples to apples. If you own a US large cap value fund, you don't want to compare it to an international small cap growth index. To make a fund's returns look good, many financial advisors compare its returns to an index that has completely different holdings. You'll know not to fall for it after reading this page.
Here's a bit of background, and I'll make it as simple and general as possible: When you buy a mutual fund, that mutual fund holds stocks. But what kind of stocks held is important. Here's the general breakdown:
Large cap funds hold stocks of large companies. Mid cap funds hold caps from mid-sized companies. Small caps...well, you got it - small company stocks.
And there's a further breakdown within that - growth, value and blend. Growth means that a company is expanding with significant earnings/revenue. Growth funds are considered to be more risky and give capital appreciation rather than dividends. Value funds buy company stock that seems underpriced, hoping for the company to start doing better. Value funds are considered safer. Blend funds have both growth and value stocks. (Remember, no one knows how a company will do in the future.)
To put it all together visually, consider this 'style box':
We'll be looking at this style box on Morningstar when we research your funds. We'll want to compare, for example, small value funds to a small value index. Apples to apples.
Let's get started.
1. Using your second internet session and your fund tickers, we'll be doing much the same thing as when we looked at fund costs. Only this time we will look at your fund's returns.
2. Let’s go to www.morningstar.com
3. Like before, in the upper left corner, enter your fund's ticker and search. If you couldn't find the ticker, enter the name of the fund company (examples: Vanguard, American, Riversource, Columbia, T Rowe Price, etc) and look through the list of funds for your fund.
4. You will see a 'snapshot' of your fund's information. But for now, we want to look at the returns. On the left side of the screen, left of the chart, look for 'Portfolio' on the list and go there.
5. There's the style box. Often a fund name will tell what is in your fund, but not always. And sometimes names are misleading - a fund may have changed it's style (this is called 'style drift'). Check the Morningstar stylebox to know for sure what you have. Write down what type your funds are (IE: large cap value, small cap blend, emerging markets growth). We'll be using that information later.
6. On the left side of the screen look for 'Total Returns' on the list and go there.
7. Now you can see your fund's returns. For a detailed explanation of returns, look at the 'Data Definitions' on the lower section of the page. We are interested in comparing your fund with it's benchmark. I like to do this is by comparing with Vanguard's index fund. Remember, an index fund tracks and isn't trying to guess where the market is headed.
8. Let’s open a third Morningstar internet session. Enter Vanguard in the Quote box and enter. Then, do a 'view all' to see all Vanguard's funds. You will be going back and forth between the two Morningstar sessions. On one session you will be looking at your fund returns and on the other session you will look at Vanguard's index fund returns (the index fund that is the proper benchmark for your fund – apples to apples).
Note: You may have a hard time finding a good benchmark. What you can do is look further down the same page on Morningstar and find 'Trailing Total Returns'. Look at the far right column: % Rank in Cat. This will tell you how a fund is performing as compared to other funds in it's category. If the rank is 30%, 70% of funds in this category did worse than your fund.
9. What you want to look at is the longest period possible under 'Trailing Total Returns'. Hopefully there's 10 years available (it depends on how long the fund has existed). Even ten years isn't really enough time.
Let's try a comparison. I'll assume you have a US (not international) large cap blend fund: Dreyfus Premier Large Company Stock B (Ticker = DRLBX). That would compare with Vanguard's S & P 500 index fund (a large cap blend). The ticker is VFINX. Take a look and see how your returns might differ.
What was the return for DRLBX over 5 years as compared to Vanguard's?
Let's try another one. Fill in the blanks:
Riversource Small Cap Growth Fund (AXSCX): ______% and....
Vanguard's Small Cap Growth index (VISGX): ______%
10. Try comparing your funds with index funds. This will tell you if you are paying high costs to underperform the associated low-cost index fund. You can also see if your fund has a lot of ups and downs.
If you have made it this far...fantastic!! You now have an excellent idea of how much you are paying for your funds and advice and you have a very good idea how your funds are performing.
Here's the hard part. Now you have to consider if you are like Connie and Jerry. Are you paying high fees? Fees you didn't know about? Are you underperforming the indexes? Do you have a sinking feeling in the pit of your stomach? If so, it's time to think about saving your nest egg.
