March 2, 2010

Are Mutual Fund Returns Really What They Say???

Ok, you hear about this great mutual fund and you jump in.  First year it returns 100%, nice, very nice.  The second year isn't so good, down 50%.  The mutual fund then claims an average return of 25% which is technically true if you just do the math and average the two years.
However, if you were a shareholder for both of those years, your return is 0%.  Whatever you gained in the first year was wiped out in the second.  Its called CAGR which is compound annual growth rate which is the 'real' or annualized return. 
As an investor, you need to be wary of many things, only one of which is the 'return' a mutual fund or your stockbroker claims to have acheived.
Since 1990, the stock market (as judged by the S&P 500) returned 10.16% but a CAGR of 8.23%.  That is a massive difference and is rarely discussed.

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