Why can’t I keep up with the market?
Q: I have been investing for years, but I never seem to do as well as my friends. I own high quality mutual funds, but I don’t even earn as much as the mutual fund company says I should earn. Do you have any idea why my portfolio always seems to lag? This is getting frustrating.
A: Without knowing your portfolio history, it is impossible for me to explain exactly why your portfolio might be underperforming. However, there are several things you need to consider when you think about your investment performance.
First, keep in mind that measuring and reporting investment performance can be tricky. If you want a thorough discussion of the issues involved, check out the “Global Investment Performance Standards,” or GIPS. This 447-page document is the gold standard for investment performance reporting. It is published by the CFA Institute and is used by all reputable investment advisors as the basis for reporting performance. GIPS is available to the public at www.GIPSstandards.org.
You should also keep in mind that comparing your investment returns with your friends’ returns is a foolish exercise. Your situation is different from their situation in ways that you cannot possibly understand without digging into the intimate details of their financial lives. Investments that are appropriate for them may not be appropriate for you and vice versa. Focus instead on making sure that your investments match your circumstances and that your portfolio is properly constructed.
Consider also that your friends are probably not giving you the full picture. I’m not saying that your friends are lying, but they may not know what they are talking about. Remember what I was saying about the complexity of investment measurement and reporting? In any case, do yourself a favor and tune out the external noise and focus on your situation.
When it comes to your own investments, there are a number of reasons why you might underperform—even if you own a well-managed mutual fund. These reasons include the effect of loads or commissions, the timing of your investments or withdrawals, and what you choose to do with dividends. An example will help illustrate what I mean.
Let’s suppose you invest $1,000 in a particular mutual fund at the beginning of the year. At the end of the year your mutual fund company reports that your fund was up 10 percent. Without any extenuating circumstances, you would expect your investment account to now be worth $1,100.
However, suppose you paid a 3 percent load to buy the fund. In that case, you really only invested $970, and your investment would have grown to be only $1,067. You did earn 10 percent, but on a lower invested amount. Over time, the effect of that load will diminish, but if you pay a load on every addition you make to the fund, your performance will always lag. The Securities and Exchange Commission has tried to help investors better understand the effect of loads on portfolio performance by requiring fund companies to report load-adjusted returns in their prospectuses, but many people gloss right over those disclosures.
Mutual fund companies also report performance assuming you made a single lump-sum investment at the beginning of the year and held the investment for the entire year. To the extent you make multiple investments over the course of the year, or take withdrawals during the course of the year, your actual performance will differ from the fund’s reported performance. If the market is going up, your performance will lag the market.
Finally, published fund performance numbers assume you immediately reinvest dividend and interest payments back into the mutual fund. If you withdraw dividends or interest payments or invest them in something else, your actual performance will not match the fund’s reported performance.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.