Why Is Mutual Fund Performance Really Misleading Math?

Imagine if you knew ahead of time how your favorite mutual funds in the stock market were going to do.

Let’s say you are retiring within the next few years and you could subtract all doubt, news, and politics. You know for a fact that you will average more than 8 percent per year.

This is not a Back to the Future trick question, Biff, you actually hold the final score for each year for all mutual funds.

Here are three of the scores:

(+86%, -39%, and -21%) / 3 years = +8.7% per year.

There is only one problem with widely promoted “average rates of return.” They do not happen in the real life of your money. The math is very misleading.

Comparatively, think back to real periods of time that some of us lived through when real math was used (i.e. the Nasdaq Composite of 1999-2001), because that time will happen again.

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What is the True Rate of Return on Mutual Funds?

While the mutual funds advertise an average rate of return of +8.7% per year, every $1 of yours inside them turns into $0.89 cents over the same period.

If you take an actual $1 through real life math of those three years above (Year 1 - $1.86 / Year 2 - $1.13 / and Year 3 - $0.89), you end up with less than you started. It turns out that losing hurts more than winning helps. So, average rates of return are dangerously misleading because they do not reflect that truth.

Average rates of return are less than helpful when it matters most in investing -- when you want to finally enjoy using your money and need some of it in retirement.

If we widen the lens of time to include all mutual funds performance, over all cycles, the average rates of return math gets worse.

Think of it like this. If I got to magically erase any mess that any of my five kids ever made, I would have had a perfectly clean house for two decades. In actuality, as I’m sure is the case in your household, that’s not reality.

The average performance that mutual funds show you did not happen either. They can exclude from their calculations any poor performing fund they wish. Just look at this chart.

All those messes have been erased by closing or sweeping under the rug of a different fund. So, that +86%, -39%, and -21% track record now can look like +86% because that is the only “track record” that survives to advertise. All that other math is wiped off average rates of return. But, for account holders who invested, these are very real losses.

As you get closer to retirement, getting the math right becomes too critical to use average rates of return based on faulty inputs like these two big ones described above.

This is why mutual funds performance always looks better than reality and can be misleading on whether your retirement income is actually secure.

Get Real Answers to Your Two Biggest Questions

We know that you have questions about financial topics you’ve heard about on TV, radio, and magazines such as mutual funds. After all, if everyone else is investing in these funds, what’s the problem?

Well, it is a big deal because it is your money. And, you need to know the truth about your ability to answer these two questions:

  • How Much is Enough (to retire)?

  • Am I Going To Be Okay?

The rate of return for a mutual fund cannot give you a true answer to the first question because of the misleading math. And, we’ve documented what could go wrong putting your eggs in the mutual funds basket.

We found something so much richer, longer lasting, and healthier than retirement for the clients that we guide through this journey of financial planning. We call it Financial Freedom.

We know the information out there is overwhelming and oftentimes self-serving. We are different. We focus on you, your needs, and your dreams through informed simplicity and a repeatable process for financial planning and investment management.

We aim to provide you with peace of mind from finally answering the two questions we all have -- “How much is enough?” and “Am I going to be okay?” That is our mission.

We invite you to subscribe to our email newsletter (sign-up form below). You will receive more information on topics such as the misleading math of mutual funds performance to help you on your journey to Financial Freedom.