Prior Years’ Performance Can Mislead
In the investment business, performance is everything, of course. So performance statistics--how mutual funds rose over 10 or 15 years, for example--are powerful sales tools for brokers.
Those statistics also are indispensable to people like newspaper financial columnists, who have to rely on the numbers to make a point or tell a story.
It’s often said that numbers don’t lie. But they can fib, sort of--especially when the subject is investment returns.
As an example, take a look at the accompanying chart. If you were a broker trying to sell an investment in a stock mutual fund that specializes in smaller stocks, which would be the sexier number to use with a client?
Obviously, a fund that rose 1,002% sounds a lot more intriguing than one that rose 781%, measuring over 15 years. Yet the time difference between those numbers is just nine months on either end: The higher figure measures the average small-stock fund’s performance from March, 1975, to March, 1990. The lower figure measures the same average fund from December, 1975, to December, 1990.
How can two 15-year time periods that basically overlap produce returns that differ by a whopping 221 percentage points?
The short answer is that stocks were in a strong bull market early in 1975, while from March to December of last year a bear market ruled Wall Street. Still, the actual percentage bull and bear moves in those nine-month periods don’t come close to equating to 221 percentage points.
The real genie here is the concept of compounding . Because the starting point of March, 1975, picks up a bull market rally in those first nine months, the mythical fund begins building on a very strong base. Add to that base the continuing returns, off and on, over the following 15 years, and you end up with a stunning 1,002%.
In contrast, the mythical fund that began to grow in December, 1975, had already missed a major bull move, so its starting base was lower. Over 15 years, that made a huge difference.
Which is the more relevant number? You could make a case for either, of course. A strong argument for remaining invested in stocks at all times is that most of the market’s gains have historically come in short bursts, like the one from March to December of 1975. If you miss those, it’s tough to make money in stocks, even in the long run. Stay invested, and the bursts provide the market gains that are then enriched by compounding over time.
The point is, an investor should always approach any long-term performance numbers with a questioning mind and take them with more than a few grains of salt. The trend is what’s most important--but not just the long-term trend. You have to be aware of what’s happened over the past few years as well.
Indeed, long-term performance figures for gold investments are particularly susceptible to abuse. Measured over the past 20 years, gold’s average annual return was 11.5%. But almost all of that return came in the 1970s and early ‘80s, when gold soared from less than $70 an ounce to more than $800.
Since then, the metal has fallen almost consistently, to about $370 today. If you only looked at the average annual return figure, you would have no reason to suspect that the number was heavily front-loaded.
Likewise, measured from March, 1980, to March, 1990, the average gold stock mutual fund gained 133% overall. But from December, 1980, to December, 1990, the gold fund return was a minuscule 13%. Again, the difference in time periods is only nine months on either end. But that March-to-December-of-1980 period represented gold’s last big hurrah before the price crashed for good.
None of this is to suggest that performance numbers aren’t important. Essentially, they’re all we’ve got in the perpetual struggle to decide where and how to invest. That old adage is especially true in the investment world: To know where you’re going, it helps to know where you’ve been.
Just don’t let yourself become enraptured by a single number. Especially in the case of mutual funds, before you buy it’s worth checking a fund’s performance over as many time periods as you can get. And compare that number to the performance of the average fund of the same type.
Remember too that quoted performance figures for the stock market are averages. That means that a lot of stocks did far better over a particular period, and a lot of others did far worse. If you invest, you have to be prepared for surprises on either side of the averages--which is why diversification is the first and last word in the dictionary of investing.
The Danger in Performance Numbers When illustrating investment returns over long periods of time, a difference of even a few quarters in the starting date of the period can mean huge changes in performance-- thanks to price spikes, and the miracle of compounding. For example, here are average returns for two types of stock mutual funds over the same basic periods, except for a few months’ difference: Small-company stock funds (15-year returns) March ‘75-- March ‘90: +1002% Dec. ‘75-- Dec. ‘90: +90% Gold-oriented stock funds (10-year returns) March ‘80-- March ‘90: +133% Dec. ‘80-- Dec. ‘90: +13%
