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Old 14.03.2012, 15:59
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Mutual Funds ROI

Recently a report was published on the performance of the Best Mutual Funds for the last 10 years. The “best” mutual fund had an average return on investment of about 8.7%. This was without taking into consideration actual costs and inflation.

The “real rate of return” is a more reliable indication of the profit or loss being made.
The time value of money is an important aspect of understanding investments and investing, as are costs. It is important to teach people to have an understanding about the IRR or the Discounted Cash Flow method which takes the time value of money into consideration.

The results of the "best" mutual funds are disappointing. Working out the return on investment for one of the "best" mutual funds with the lowest expense ratio showed a much lower real rate of return. For that, actual annual data were used (not averaged out), also taking into account inflation (CPI), opportunity cost, tax implications and costs mentioned on the website of the mutual fund.

The 12 year moving average return on investment dropped to 1.86% (instead of 8.7%). A $10.000 starting capital with an annual rate of return of 1.86% would have grown to $12.475. In other words, in 12 years’ time a profit would have been made of $2475 for the client.

However, an important point to mention is the investor behavior related to market-timing/sector rotation. Various studies have shown for years that the “average mutual fund investor” does not make what the actual mutual funds make: “the performance of the average investor in an asset class lags the average performance of the asset class itself by an average of 1.95 percent per year over the past fifteen years” Morningstar (2010), Vanguard and others: “over 10 years investors earn 1.5% less annually than the funds they invest in” This means that the average investor over the last 12 years did not make any money at all. In fact most professionals and non-professionals lost money.
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Old 14.03.2012, 18:20
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Re: Mutual Funds ROI

Interesting post. Also because it's mostly word-for-word identical to the two comments here.
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Old 14.03.2012, 19:42
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Re: Mutual Funds ROI

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.

The results of the "best" mutual funds are disappointing. Working out the return on investment for one of the "best" mutual funds with the lowest expense ratio showed a much lower real rate of return. For that, actual annual data were used (not averaged out), also taking into account inflation (CPI), opportunity cost, tax implications and costs mentioned on the website of the mutual fund.
Wot a load of bollox.

CPI? Which CPI?
Opportunity cost - you can't define that unless you know the end user. A corporation or pension fund might have opportunity cost X, Trader J - Y and Joe Public -Z
Tax implication? Unless you sell the fund there is no tax implication. Or maybe you optimise your management with regards to taxation.
Costs? Seriously?

It does sound very "scientific" though.
I'm standing by to be further "educated".
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Old 14.03.2012, 20:37
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Re: Mutual Funds ROI

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Wot a load of bollox.
Why a load of bollox?
I'm a bit biased as I am of the view that any money made is eaten up by fees etc of these mutual funds, and that beating the leading market benchmark (i.e. generating alpha) takes a lot of skill but mostly luck.

What Trader J is saying is a bit hazy, because it doesn't go into too much details, but I won't be surprised if it's true.

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CPI? Which CPI?
Just take any CPI or the average of CPI in the western world, it's likely to have been north of 3% on average over the last 10 years. So it's not at all surprising, that if the average is 8%, take away 3% inflation, and around 2% risk free return (Savings account over the last 10 years for arguments sake), take away the 2% usual fee and you're left scratching your balls.
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Old 14.03.2012, 21:13
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Re: Mutual Funds ROI

Maybe we can clarify some things here as there seems to be a few messages in the post, some of which have merit. I'll see if I can help.

All investments are affected by inflation, so there is no opportunity cost of investing in mutual funds vs stocks vs bonds in that regard. Your real return is the nominal amount less inflation for the period of the investment.

All investments that are placed with an intermediary, whether it is a mutual fund or through a broker account have fees charged on it. Mutual fund fees seem to be around 1.5% on average according to this. You obviously wont see fees on an index.

So there you go. To work out your true returns, you need to deduct fees and inflation from the fund performance. Fees are the part that cost.

The cheapest way to get the average return of whatever market you are interested in, is to buy an Exchange Traded Fund (ETF) that replicates the index. You will get the average market performance less the cost of your placing the trade. Alternately, you can try to select a fund to beat the market. And that is an altogether different challenge as it has been quite rightly pointed out that most funds underperform the market. This is actually quite logical as the funds (professional investors representing institutional money) largely ARE the market. So they should receive an average return less fees. Hence a tendency to underperform.
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Old 14.03.2012, 21:28
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Re: Mutual Funds ROI

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All investments are affected by inflation, so there is no opportunity cost of investing in mutual funds vs stocks vs bonds in that regard. Your real return is the nominal amount less inflation for the period of the investment.
Agree on the most part of your post, however the inflation part I have to disagree a little bit as some investments are positively affected by inflation, there are many defensive plays, from good yield blue chips, gold and real-estate (I'm bearish on the latter two) to CPI linked notes which protect against inflation. But as I said these are defensive plays so you are not going to make money but purely preserve your wealth.

I have to add, inflation is forecast to come down, and if the perceived housing bubble really bursts this time around, then who knows, making 1% or even losing 1% might look good on paper!

In today's volatile market, if you don't lose money as a private investor than you're doing good! Hoping for the best is never a good strategy.
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Old 14.03.2012, 21:59
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Re: Mutual Funds ROI

I stand corrected on inflation linked securities, e.g. Treasuries. Was mainly commenting on the opportunity cost, which I interpreted as another type of investment per se. Good that you clarify that.

As for blue chips, yield and gold, these are hedges due to the form of investment. Regardless, your reported performance will still need to deduct inflation to get the true return.

You correctly point out the hedging qualities of these investments. Certainly gold and real estate rise with inflation because they are real assets. Inflation is after all a monetary phenomenon that affects paper money. Blue chip stocks (and others) represent companies and can to some extent pass on some of the cost of inflation on to their customers (as most people seem to have found out with their utility bills...), but this is no guarantee against inflation.
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Old 14.03.2012, 22:34
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Re: Mutual Funds ROI

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Mutual fund fees seem to be around 1.5% on average according to this. You obviously wont see fees on an index.

So there you go. To work out your true returns, you need to deduct fees and inflation from the fund performance. Fees are the part that cost.
Mutual fund fees are embedded in the NAV, so your 8pct a year return is net of fees.
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Old 14.03.2012, 23:03
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Re: Mutual Funds ROI

Fair enough, not a fund accountant, but your returns are still impacted regardless, i.e. would be more than 8% otherwise. I have a feeling you still get charged entry/exit fees depending on the product, though have not looked at a mutual fund for a long time. Suspect fees have come down (used to be 5% front end load back in the day - ha! Imagine it is all back end load now to hide those costs. And then real returns are still affected by inflation.
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Old 14.03.2012, 23:19
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Re: Mutual Funds ROI

Retail is 1.5pct front end. No back end fee. More than 8pct... Okay... Considering that at 7% you have doubled your nominal wealth in 7 years... I can live with 1.5pct front end if I stumble on a 7 pct / year fund.

The real returns are indeed affected by inflation. As opposed to the cash in your pocket which isn't?
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Old 14.03.2012, 23:28
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Re: Mutual Funds ROI

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Retail is 1.5pct front end. No back end fee. More than 8pct... Okay... Considering that at 7% you have doubled your nominal wealth in 7 years... I can live with 1.5pct front end if I stumble on a 7 pct / year fund.

The real returns are indeed affected by inflation. As opposed to the cash in your pocket which isn't?
I always believed you devided the compound yeild into 72 to get the no of years to double your money, so at 7% it's not 7 years but just over 10.
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Old 14.03.2012, 23:43
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Re: Mutual Funds ROI

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Retail is 1.5pct front end. No back end fee. More than 8pct... Okay... Considering that at 7% you have doubled your nominal wealth in 7 years... I can live with 1.5pct front end if I stumble on a 7 pct / year fund.

The real returns are indeed affected by inflation. As opposed to the cash in your pocket which isn't?
Not disagreeing with you - just trying to clarify what I think the OP meant by calculating your real returns. Sure, good luck in your investment selections and 7pct is indeed very respectable. All I would say is that if you did not have a high conviction in your abilities to select a good investment, then you could simply put that additional 1.5% in an ETF and get the market average return. Equities over the long run have provided 6.6% on average IIRC. I would advise against putting it into whatever equity index you are interested in when they are at high levels on an historical basis, but then that is the value investor in me...
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Old 14.03.2012, 23:46
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Re: Mutual Funds ROI

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I would advise against putting it into whatever equity index you are interested in when they are at high levels on an historical basis, but then that is the value investor in me...
Hardly true of Nasdaq, it's about half it's peak of 12 years ago, FTSE well down on it's high 12 years ago. The PE's are not particually high today.
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Old 14.03.2012, 23:59
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Re: Mutual Funds ROI

I didn't particularly mean today, just in general as a rule of thumb. You make a very good point and indeed the Price to Earnings ratio is what I tend to use as a reference point. I haven't looked at the market P/E ratios are, but I judge anything over 20x as not offering much value. A P/E closer to 10x is more acceptable. Having said that I invest in individual stocks, but these are what I would consider reasonably conservative guidelines for most investments.
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Old 15.03.2012, 00:11
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Re: Mutual Funds ROI

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I didn't particularly mean today, just in general as a rule of thumb. You make a very good point and indeed the Price to Earnings ratio is what I tend to use as a reference point. I haven't looked at the market P/E ratios are, but I judge anything over 20x as not offering much value. A P/E closer to 10x is more acceptable.
If of course earnings are sustainable... which they usually aren't.
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Old 15.03.2012, 00:42
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Re: Mutual Funds ROI

We are agreeing then - paying 20x earnings is less prudent than paying 10x earnings.

For me, I like to look at past average earnings to begin with. Some companies have relatively stable earnings over a normal business cycle of say 7 years - which provide a good reference point for the sustainability of earnings over good and bad years. Of course the past few years haven't constituted a normal business cycle but therein lies the beauty of doing fundamental analysis. You have to adjust your calculations to take into consideration that we are not out of the water yet. For me, this lends even more resonance to taking a conservative approach to investing and not paying too much for what you are buying. I think the lessons of the 1930s provide a valuable guage for today. If you haven't read Benjamin Graham's 1949 edition of The Intelligent Investor, I highly recommend it.
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Old 15.03.2012, 01:20
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Re: Mutual Funds ROI

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I always believed you devided the compound yeild into 72 to get the no of years to double your money, so at 7% it's not 7 years but just over 10.
Indeed. Two rules of thumb any fixed income trader has ingrained on their soul. 7% is a doubler in 10yrs and 10% is a doubler in 7yrs.
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Old 15.03.2012, 01:31
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Re: Mutual Funds ROI

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Indeed. Two rules of thumb any fixed income trader has ingrained on their soul. 7% is a doubler in 10yrs and 10% is a doubler in 7yrs.
Or, to be more general, the rule of thumb for exponential processes (which includes the compound interest from investments) is that the doubling time in years is 70/APR where APR=annual percentage rate.
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Old 15.03.2012, 01:36
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Re: Mutual Funds ROI

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We are agreeing then - paying 20x earnings is less prudent than paying 10x earnings.
As with everything it is subjective. Firstly blindly following PE leads to "value traps" the most common of which is lack of earnings growth with a growing cost base. Too much leverage is another. ROIC is a better but less well understood measure favoured by Buffet and many practitioners. Simply put it is the cashflow based return a buyer would receive when buying all the debt and equity of a company. This is the number that really makes sense because it states before a debt tax shield how much do I get out for how much I put in.

I like value stocks too, but a company with good double digit earnings growth is cheap at 20* where one with a failing business model (Post & Telcos spring to mind) are not particularly cheap at 10*.
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Old 15.03.2012, 01:45
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Re: Mutual Funds ROI

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...................., and that beating the leading market benchmark (i.e. generating alpha) takes a lot of skill but mostly luck.

Alpha should not be considered just returns above a benchmark. Firstly we are talking about EXCESS returns so the classical models say we adjust for risk free, but most importantly alpha is the excess return we have (the intercept on a regression model) when we take into account ALL RISK Factors.

Don't get sucked in by a fund manager who has made 4% over risk free when the S&P has a return of 2% above risk free. Far more likely his return is some alternative source of beta rather than true alpha.

Beta (market based returns) are still going to be the bread and butter of most peoples portfolios. That being the case the most sensible financial planning move most people can make is researching the cheapest way to take on this risk. ETFs are todays instrument of choice for that.
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