Total Returns Versus Investor Returns
June 4, 2008 – 7:33 amI think Total Returns are pretty meaningless for the majority of “average” investors, myself included. Total Returns, as published in a funds annual report or on a site like Morningstar.com specify how much you would have earned if you invested in a fund at the beginning of a year and held your investment until the end of the year.
But here’s the problem:
- You (and I) didn’t buy all of your shares on the first day of the year. We bought them throughout the year. This could have helped or hurt us depending on the daily and monthly swings in prices.
- We also may have sold some shares, exchanging them for purchased goods or switching to a fund we felt was a better choice (likely based on nothing more than recent “total returns”)
Morningstar.com publishes total returns on thousands of funds. If you click over to their left menu item titled “Total Returns” they also have something very interesting hidden away on the page. Once you navigate to this page, just above the chart you will notice two tab options: “Total Returns” and “Investor Returns”. Ahhhh. Now we’re getting somewhere.
You see, Morningstar not only tracks total fund performance, but it tracks investor performance based on dollars flowing into and out of a fund. Thus the “investor return” is a dollar-weighted return, meaning it takes into account the specific flow of funds into and out of the fund.
If investors pull money out and the fund and the fund return improves, then the investor’s return will be lower than the fund’s published total return. Likewise if investors take money out of a fund before it’s price drops dramatically, then the investor return could be higher than the total return of the fund.
Why is this information useful?
Reviewing a funds’ investor return can give you a glimpse of how investors use this fund. A broad-market index fund typically has similar total and investor returns. According to Morningstar the Vanguard Index 500 fund had investor returns that were within a few tenths of one percent every year from 2001 through 2007.
Profunds UltraSector Mobile Telecomm Inv (WCPIX), tells a different story (I chose this fund as a random example only). For this fund investor returns varied from fund returns by anywhere from 8% to 31% depending on the year, and in all but one years the investors’ return was lower than the total return. This doesn’t make the fund a good or bad choice by itself, but it does indicate that few people buy and hold this fund for an extended period of time.
Although this may be an extreme example since the fund I chose is sector fund, similar results can be seen on a variety of actively managed funds.
Why Should You Care?
Good question. If you’re a buy and hold investor, then your return and the funds’ total return should be roughly the same. The only differences would be caused by investing over time versus in a lump sum. However, even if you are a buy and hold investor this information is quite valuable. Why? The differences in investor and total returns are one indication that owners of your fund are trading and trying to time the market (or are just bad or short-term investors). THEIR bad decisions cause YOUR returns to go down, because they caused increased fees and capital gains impacts that you will have to pay. Since you’ll be holding on to your fund through the end of the year, you’ll get a more than fair share of short-term capital gains and losses, especially if people have bailed out of a fund recently. And pay taxes is no fun, especially if your fund had a down year!
Investor returns are typically below total returns because people tend to pour money into “hot” funds. I haven’t seen an article on this in a while, but I read once that funds with a four or five star rating from Morningstar often see money flow in very quickly. This huge influx of funds has an impact on performance as well because some funds can’t stay true to their strategy with large portfolios (i.e. there just aren’t that many small-value type companies when you have several billion dollars to invest). Fund managers may also feel obligated to invest all of the inflows even though he or she may not have a great idea or place for the funds (who want to pay a fund manager to keep money in cash?).
Summary: Before you invest be sure to check out the total AND investor returns. The only place I’ve seen investor returns data is on Morningstar.com, but there may be other data sources as well. What I haven’t seen, however, is a table of investor returns in any fund prospectus. They will (most likely) show data about tax efficiency and recent capital gains distributions, but I doubt many will show data on how investors use the fund and trade into and out of it.
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