The Independent Market Observer

Navigating Mutual Fund Results

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Dec 30, 2015 2:30:00 PM

and tagged Investing

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mutual fund resultsThis post originally appeared in February 2015, but it’s worth a refresher as we start a new year.

Did you know that South Boston is actually to the east and East Boston to the north of the city? And that there’s one local highway where you’re really traveling south but on a northbound route at the same time? I’m not sure who drew up the plans, but I think they might have had a screw loose.

Trying to make sense of mutual fund gains and losses can be equally confusing.

How mutual funds work

If a fund is down for the year, how is it that the fund can make taxable distributions of profits from specific share investments at the same time? Isn’t this like heading south and north at the same time on the same road?

Not precisely, but to understand why, we have to go back to how mutual funds work. Essentially, a mutual fund is a collection of investments in different stocks or bonds, bought and sold at different times as the manager decides is most beneficial for all shareholders, each of whom owns a piece of the entire portfolio.

The outcome for those shareholders depends on the performance of individual companies the fund invests in, but those individual results will differ from the results of the fund as a whole. In exactly the same way, the buy and sell dates of the shares the fund owns will differ from the performance dates the fund reports. It is indeed possible for a stock to have headed north at the same time a fund has gone south.

A simplified example

Suppose a mutual fund owns stock only in company ABC. The fund buys one share at $100 on January 1, 2013. The fund managers are good analysts and buy right; the stock soars to $150 as of December 31, 2013. Both the stock and the fund are up.

Then, in 2014, the stock drops to $125 by year’s end, and the fund managers decide to sell. For 2014, the fund’s shareholders would see the following:

  1. The sale of the stock would trigger a taxable distribution on the $25 gain.
  2. The fund itself would lose money for the year, as its single holding declined in price from $150 at the start of the year to $125 at the end.

The fund has gone south while the stock itself, over the holding period, if not the past year, went north. When looking at real mutual fund results, the dynamics are more complicated, but the underlying process is the same. The results of individual investments over different holding periods can be substantially different from that of the fund itself over a set time period.

Taking a tax detour

Although it can be frustrating to see both a tax bill and a loss on an investment, look at it this way: the tax bill has come later than it might have. You enjoyed the previous year’s gain in that fund while having the taxes deferred until just now.

Like many aspects of investing, this sort of result appears counterintuitive until you look at the underlying reasons—and then it makes perfect sense. Unlike, of course, the roads in Massachusetts, for which I’ve yet to find a good explanation.

Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results. Talk to your financial advisor before making any investing decisions.

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