Mutual Fund Returns: Some Wild Swings

Putting things into perspective

Roger Wohlner

As I review my client accounts as of the end of the first quarter, the trailing returns on most of the equity mutual funds and ETFs that I use in client portfolios look like a roller coaster.

This is in large part due to the fact that the S&P 500 reached its low point of the 2008-09 market downturn on March 9, 2009. This means that the trailing three-year returns for a great number of funds are based off of a base point that was just above the market lows. The average annual three-year returns for a great many funds are in excess of 20 percent.

However, when looking at trailing five-year returns, the base time frame is April 1 of 2007. This is before the market downturn and just prior to the S&P 500 reaching its all-time high of 1,565 on October 9, 2007. Therefore, in general the average annual trailing five-year returns on many funds and ETFs are much lower. In some, cases these returns are even negative.

The point is that trailing funds returns are useful, but they need to be taken in the context of the trailing time period. This has rarely been more pronounced than over the course of the last decade, dating back to the dot-com crisis that commenced in early 2000. The disclaimer that “past performance is not an indication of future returns” has never been truer.

Does this mean that you shouldn’t consider a fund’s history when evaluating whether to buy that fund or hold onto it if you already own it? No, not at all. Rather, you need to ask yourself a number of questions about the fund and where it fits in your overall portfolio.

How do the fund’s returns compare to its peers? Over any time period, the returns of a fund should be viewed in context. If your fund earned an average of 20 percent per year over the past three years, that is a wonderful return. However, you should also look at how that number compares to returns of other funds in the same category (for instance, large-cap blend).

How does the fund perform in various types of market environments? In some cases, a fund may have held up better than most of its peers during the market downturn, only to underperform during the market rally that has ensued since March 2009. In other cases, the reverse situation may have occurred. It is vital to understand how your fund reacts in different market environments. One cautionary note: This may vary from market crisis to market crisis. Case in point: There were several large-cap value funds that did quite well in the market downturn from 2000-2002. The same types of investments that served their shareholders well during that timeframe blew up on them during the 2008-09 market decline, however.

The most important question to ask is: Where does this fund fit within my overall portfolio? A mutual fund, ETF, or any other type of investment vehicle is nothing more than a tool to help you achieve your investment and broader financial goals. I often utilize index funds for their stylistic consistency and low expenses. I’m not knocking active management, and I do use a number of actively managed funds in client portfolios. However, when using active managers, be sure the added expense is justified by the value you feel the managers and their investment philosophy add to your portfolio.

Evaluating the performance of mutual funds has never been an easy task. The extreme swings in performance over the past several years make this task even harder at this juncture.

Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. He recently cofounded Retirement Fiduciary Advisors to provide direct investment and retirement planning advice to 401(k) plan participants. Roger also blogs at Chicago Financial Planner.