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(Editor’s Note: Following is a guest submission from Greg Retzloff, publisher of the well-regarded financial blog Workingman’s Dollar.)
By Greg Retzloff
www.workingmansdollar.com
Fund companies continue to post their total return figures in ads, carefully pulling together lists of funds that together compose what looks like a winning team. Morningstar ratings are often paraded along with these return figures as though Morningstar ratings have any real predictive power. Rarely mentioned in these stellar lists are sales fees, fund expenses, trading costs and taxes.
Professional investment advisors and informed individual investors know of the cumulative long-term effect of these costs on the real performance of mutual funds. But often both professional investment advisors and individual investors gladly ignore these costs as though they are just inconvenient reminders of the otherwise exceptional performance of the fund that they either currently own or want to buy.
Costs are important – very important! Even the best index funds from companies such as Vanguard and Dimensional Fund Advisors (DFA) have them, and actively managed funds will have added costs because of the expenses associated with active management and more frequent trading.
It is unfortunate that investors are not provided with the cost-adjusted returns of funds in a single figure. These figures make a critical difference in the final investor returns. Neither the mutual fund industry nor the SEC require an actual “investor return” figure demonstrating the return an that investor would have received after all costs are deducted from total-return figures. So-called total-return figures do factor in management fees, but do not generally include trading or tax costs.
For example, the Dodge & Cox Stock fund (DODGX) posted a 10-year total annualized return of 5.51% according to Morningstar. This number factors in the expense ratio, but does not include the tax costs associated with the fund’s trading. The fund’s tax-adjusted return was just 4.04% for that period.
John Haslem wrote an interesting paper in 2006, “Assessing Mutual Fund Expenses and Transaction Costs.” In the paper he proposes an all-inclusive expense ratio that would include the following: regulatory expense ratio (management fees, 12b-1 fees, and other expenses), brokerage commissions, and implicit trading costs (generated by portfolio turnover). Together these would constitute a total expense ratio. This number would help an investor determine the true historical returns of a mutual fund.
In the Meantime
The single total expense ratio suggested by Mr. Haslem doesn’t yet exist, but there is a good way to get a handle on the historical return of a mutual fund with a figure that does exist.
The tax-adjusted return figure as provided by Morningstar is close to the actual total return figure we are looking for because it provides us with something resembling actual investor return over time. This figure indicates the total return of a fund less taxes and sales charges. You can find this number on Morninstar.com for a given fund based on three-, five- and ten-year time periods.
A fund that has been a consistent performer and kept costs and taxes low in the past is likely to be a good performer into the future. But, as always, past performance is no guarantee of future results.
A few days ago I was in a store looking at smokers (as in meat, not cigarettes) trying to decide on a new model. I developed an interest in the Big Green Egg ceramic cookers about five years ago and it has since blossomed into either a passionate hobby or expensive obsession, depending on whether you are talking to me or my wife.
Anyway, the Muzak in the store was playing “country classics,” I suppose you would say, none of which I was paying attention to until an old familiar song my college roommate used to wear out on our cassette deck came on:
The preacher man says it’s the end of time
And the Mississippi River she’s a goin’ dry
The interest is up and the stock market’s down
And you only get mugged if you go downtown
It was Hank Williams, Jr. singing “A Country Boy Can Survive,” which (the miracle that is Google tells me in 0.37 seconds) was released in 1981.
My first concern was that ol’ Hank couldn’t find a way to make “Interest rates are up” work in the third line. “The interest is up”? What does that mean? I mean – c’mon – mine was right there!
But I quibble.
The thing that really stood out to me about that song was how appropriate Hank’s lyrics could have been today (except, of course, for the high interest rates). In fact, as I dug deeper into the history of the song, I learned it has actually had three different iterations in the past three decades.
Here’s the opening verse from the version that was released in anticipation of the CERTAIN DOOM THAT WAS OTHERWISE KNOWN AS Y2K:
Computer man says it’s the end of time
December 31st 1999
People buyin’ up all the surplus things
Afraid of what the New Year will bring
Seems kind of quaint now, doesn’t it?
And then there was the version that was released after 9/11, which is decidedly more rousing:
People think it’s nearly the end of time
Cause we’re together and we’ve drawn the line
Our flag is up, the stock market’s down
But we’re all united from the country to the town
So what can we discern from the fact that Hank Williams Jr. was able to parlay an apocalyptic song written in 1981 into three different iterations spread over 20 years? (I mean, besides the fact that it must be a seriously catchy tune.)
Three things, I think:
1. Doom-and-gloom is a recession-proof business. If we aren’t worried about today, we’re worried about tomorrow, and there are always plenty of people around to help make sure we’re worried.
2. It always seems worse today, in real time, because we worry about all the unknowns as well as the knowns. In retrospect we can see that Y2K was no big deal and 9/11 was a very big deal. But in real time every potential crisis seems like a big deal.
3. From despair comes defiance, and sooner or later that quality galvanizes us and pulls out of the quagmire. Until, inevitably, we let our guard down, forget our lessons and have to learn them all over again. It is a cycle as inherent to humans as the seasons are to nature.
It occurs to me that Hank hasn’t gotten to the 2008/09 version of “A Country Boy Can Survive,” so I want to go ahead and get my own version down ASAP before he comes around for Version 4.0. So here goes:
Talking heads say it’s the end of time
Cause the budget deficit’s gone sky-high!
TARP & TALF are the words today
And we’re printing tons of money in the U-S-A!!!
Here’s hoping that seems as quaint in ten years as the Y2K version does today…
