Quick little three-step lets investor calculate how fund is doing

Your Funds

Your Money

October 17, 2006|By Charles Jaffe | Charles Jaffe,Marketwatch

Mutual funds have been around for more than 80 years, so you'd think that every means of measuring performance has been around nearly that long.

But investment research firm Morningstar Inc. recently announced that it is coming out with a new performance gauge, and investors should not only pay attention, but should develop their own version of it, too.

A fund's year-to-date or year-end results represent what the fund has done but - as they say in infomercials - individual results may vary. Your personal percentage return in a fund over time will match the published numbers only if you do not add to or withdraw from your holdings in a given year. Make changes to your account and your personalized return will vary. Investing the first of each month generates different results from investing on the 15th or from investing quarterly, even if the annual amount being plugged into the fund is the same.

Morningstar Investor Return is a measure of a dollar-weighted return, estimating the collective performance for all investors in a fund.

Dollar-weighted returns show whether investors are chasing performance, buying funds only after a big run-up or losing faith and selling before a rebound. The gap between investor return and total return often grows wider when investors refuse to sell a losing fund, hoping for a return to break-even.

Morningstar's new measure (available on its Web site in November) helps to show how a fund company "preserves the investor experience."

Clearly, most investors get less from a fund than the published return. Dalbar Inc. of Boston has tracked investor behavior since 1986 and found that over a 20-year period - through a raging bull market and a snarling bear market - investors achieved an average annualized return of a little less than 4 percent, compared with a return of nearly 12 percent from a buy-and-hold strategy using the Standard & Poor's 500 index.

Consider an investor who opens the year by throwing $10,000 into the XYZ fund. By June 30, the fund is up 10 percent and the investor adds $5,000 more. The fund then cools off and ends the year right back where it started. On paper, the fund had no gain or loss, but the investor's $15,000 investment is worth $14,400.

That's a 4 percent loss in a fund that broke even for the year; at the time the investor had the most money in the fund, it produced the worst results.

A fund's volatility generally determines the variance in dollar-weighted returns. Whether the results prove that you beat or lost to your own fund, the information is worth pursuing because it provides a truer picture of the performance of your investments in the fund.

If you want to see how your investment in the fund compares with its published performance number, grab a pencil, a calculator and your most recent statement showing all activity in a fund this year. Thus armed, it's a quick little three-step to a rough-dollar-weighted calculation; here's how to do the legwork:

Step 1: Subtract your account's balance at the start of the year from your current balance. Cut the result in half (even if it's negative) and then add back the money you had in the fund at the start of the year. This is your "average monthly balance."

Step 2: Subtract from your current account balance the amount you had in the fund at the start of the year; subtract the amount of any additional investments, too. (If you made withdrawals, add those amounts back in this step.) The result will be your "total gain." If negative, it's your total loss.

Step 3: Divide your total gain (or loss) by your average monthly balance, and multiply the result by 100. The result is your dollar-weighted total pretax return for the year.

It's not perfect. If you made all of your additions either early or late in the year, that can skew the numbers. But you will be left with a number for performance that looks at how all of your dollars have done this year, giving you a more accurate impression of just how well or poorly you've done in a fund. Compare the results to the fund's total return to see if your own investment habits - particularly chasing performance - are part of the problem.


Charles Jaffe writes for MarketWatch. He can be reached by mail at Box 70, Cohasset, MA 02025-0070.

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