So let's say you're flipping through this month's issue of Investment Advisor magazine. Somewhere in the middle you come across a four page spread on this particular mutual-fund portfolio manager — we'll call him "Bob" — at the firm of Neuberger Berman. Bob has been managing his particular fund for about four years, according to the stat table in the article. His fund's returns were as follows:

2003:   43.30%
2002:   -13.10%
2001:   -18.01%

Looks pretty okay, right? I mean, 43.3 percent is a stout return, more than making up for the previous two years' approximate loss of 31.1 percent, right?

Well, no. Not really. No.

Let's bring those big percentages — wow, that 43 sure is a big number! — into the real world, via this quick 'n' dirty scenario. You've worked hard and put together a tidy sum of $10,000 and are now ready to invest it at the end of 2000. For whatever reason, you decide the mutual fund run by Bob is a worthy choice for your money, so you sign, seal, and deliver it to the silk ties at Neuberger Berman.

Three years pass. "Who Wants to Be a Millionaire?" comes and goes, and it's now January 2004. The 2003 Year End statement arrives from Neuberger Berman. Eagerly you tear into the heavyweight parchment of the envelope. You flip open the glossy pages and peruse the findings. You notice that your fund is prominently featuring a few numbers regarding its recent performance. And there it is, in bold letters: The fund was up 43.3 percent for the year 2003! Wow! So with shimmering double-digit gains like that, just how much has your $10,000 turned into in the last three years?

About $9,686.

That's right. You've still lost money. Even better, you paid Fund Manager Bob (and his hoity-toity bosses, of course) expense fees of 1.7 percent per year to lose your money. In this case, you paid him about $523 grand total.

Golly. Thanks, Bob.

All this is because the numbers in Bob's stat table in the article are misleading, and probably not by accident. (Experience and cynicism have taught me that few things which emanate from our hallowed Wall Street do in fact emanate by accident.) If you start off with an investment of $10,000, and lose 18.01 percent the first year, your investment is down to $8,199. Your investment would now have to rise 21 percent — not 18.01 percent — from that point just to get back to $10,000. (The 18.01 percent drop from $10k equates to $1,801. An $1,801 rise from $8,199 would be a gain of 21 percent.)

See how easy it is to fiddle with reported investment returns, particularly when comparing returns year-to-year? Drop 18.01 percent from $10k, and then drop another 13.1 percent from there, and you need a rise of about 40 percent just to get you back to the $10k mark. Yucky, yucky.

Anyhow, here's a page showing my table of calculations regarding Bob's returns from January 1, 2001 to January 1, 2004. This shows the returns as reported in the magazine, as well as the real returns which reflect management fees and expenses. If you'd like to see what actually happens to the money, here's a simple chart of it, year by year. Notice how the seemingly small management fee (1.7 percent per year) is, in this case, enough to turn a tiny gain of $210 over three years into a loss of $313.

To be somewhat fair — at least in the manner Wall Street would desire — I'll point out that the S&P 500 went from 1320 (January 2, 2001) to 1111 (January 1, 2004) in that same period of time as Bob's accomplishments above. This would equate to an annualized loss of about 4.47 percent (including dividends) per year for an S&P 500 index investor. Counting fees, your money in Bob's fund dropped at an annualized rate of 1.06 percent. So comparatively speaking, you did "better than the market." Problem is, "better than the market" will only take you so far when market-wide returns are in negative territory.

Eventually, you have to get away from "relative returns" (which give birth to the "Yeah, I lost money, but not as much as the market overall" syndrome, and which Wall Steet adores dishing out) and grasp onto the concept of real returns. Good market or bad, good economy or bad, you have to make money rather than lose it.

Sometimes taking just a few years of losses can knock the shine off most anything — even a 43 percent gain.

Michael | November 19, 2004

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