Skarbeck: Mutual funds’ rate of return paints misleading picture

Ken Skarbeck InvestingThe calendar can provide the investment industry the sleight of hand needed to grab investors’ attention when advertising investment performance.

Currently, any mutual funds or investment advisers that quote their five-year annualized rates of return (ending Dec. 31, 2012) still have the calamitous year of 2008 included in those figures. The S&P index lost 37 percent in 2008, which smothers the annualized five-year index return down to an uninspiring 1.66 percent.

But look what happens when the end of this year rolls around. Even if the market does nothing for the remainder of this year, when 2008 drops off the ledger, the five-year annualized rate of return on the S&P 500 rockets to 13.9 percent. Magically, investment marketers can change their tune toward eyebrow-raising figures that attract investor cash.

A similar effect occurred at year end for the popularly quoted 10-year investment return. Dropping off the 10-year roll was 2002, the worst in the three-year slide following the burst of the market bubble.

No longer is a 10-year performance encumbered by the 22.1-percent drop in the S&P 500 for 2002. Thus, the 10-year annual rate of return on the S&P 500 index jumped from 2.9 percent to 7.1 percent.

Going forward, the entire post-bubble market crash, and its 37.6-percent cumulative loss from 2000-2002, has been erased from all 10-year performance records.

Of course, seasoned investors probably won’t feel they have scored frothy gains over the last five or 10 years, because they were in the market in 2000-2002 and 2008. Their portfolios felt the brunt of the tech bubble crash and the credit crisis.

Most investors do not attempt to time their buys and sells with an “all-in” or “all-out” approach. And those who do are often seduced into the market when prices are high, and vice versa, then bail out when markets get gloomy and prices are cheap. A cardinal mistake was made by investors who piled into the market as the market reached its 2007 high.

While it’s fantasy to believe you can pick the tops and bottoms of markets, investors can learn something by examining their behavior at market peaks and bottoms. If they’re thinking properly, it shouldn’t be too difficult for them to tap on the brakes and harvest profits when everything seems wonderful with the stock market and prices are high, or pump the accelerator a few times when the world is pessimistic and prices are low. Investors who confidently made large purchases at the end of 2008 have reaped handsome profits.

Our generation has been through two very testy market periods in the last decade or so. Investors who were able to temper their emotions and think rationally had periodic opportunities to exploit the difference between business valuations and market prices and assemble a respectable long-term result.

Ideally, investors should have a viewable record of how their investments have performed under all market environments. We have found that a value-oriented investment methodology can mitigate losses in downturns and pave the way for good results when markets rise. There will most certainly be opportunities in the future to pare back your portfolio when prices are high and buy more stocks when prices are low. Will you be prepared?•


Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or [email protected]

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