Double Digit Returns - Myth or Reality?

[tmount]

I think everyone will agree. The past few years have been more feast than famine. The Dow and S&P both reached records. A rising tide floats all boats, right?

Maybe not. I'll offer a personal story. I'm no expert. In fact, I'm probably slightly different (ahead or behind, you decide) the average. I contribute 11% of my (pre-tax) income to my 401(k). I've been doing it for at least 5 years (wow, it seems like such a short time, but yet so long ago). I won't talk about my earlier years, like everyone, they were bloody.

But, recently, I've tried to make the right decisions. Diversify. Stocks (foreign and domestic), Bonds, Cash. I picked funds that had 4 and 5 star MorningStar Ratings. That had upwards of 15% average annual returns for 1 year, 3 years, 5 years, 10 years. Yet, for one particular example, as of today, it is -6.98%.

So, is this just the natural progression of things? Of course, past performance is no indication of future performance, but how else does one asses one fund over another? Being the gamer, I left one of my old (smaller) 401(k) accounts in one of those Retire "2045" accounts; it lost more than my own menagerie of funds.

I know there are many folks smarter than I - have you encountered this type of situation? Are double digit returns a myth?

 

[Matt]

I think everyone will agree. The past few years have been more feast than famine. The Dow and S&P both reached records. A rising tide floats all boats, right?

Maybe not. I'll offer a personal story. I'm no expert. In fact, I'm probably slightly different (ahead or behind, you decide) the average. I contribute 11% of my (pre-tax) income to my 401(k). I've been doing it for at least 5 years (wow, it seems like such a short time, but yet so long ago). I won't talk about my earlier years, like everyone, they were bloody.

But, recently, I've tried to make the right decisions. Diversify. Stocks (foreign and domestic), Bonds, Cash. I picked funds that had 4 and 5 star MorningStar Ratings. That had upwards of 15% average annual returns for 1 year, 3 years, 5 years, 10 years. Yet, for one particular example, as of today, it is -6.98%.

So, is this just the natural progression of things? Of course, past performance is no indication of future performance, but how else does one asses one fund over another? Being the gamer, I left one of my old (smaller) 401(k) accounts in one of those Retire "2045" accounts; it lost more than my own menagerie of funds.

I know there are many folks smarter than I - have you encountered this type of situation? Are double digit returns a myth?

You can't ever guarantee double digit returns, though they have been quite easy in recent years, anything with a reasonably tight correlation to the stock market should be easily up there.

Regarding Morningstar, I almost wrote a post on how to read a report by them, I think I didn't have a report handy to work from in the end and I moved on. However, the 4/5 star ratings are to be ignored for the most part. By that I mean certainly don't accept a 3 (or probably a 4) star rating, but a 5 does not mean a good fund option at all.

The reality is that if you have a few different funds you will have a lot of overlap, funds, especially managed ones frequently will have the same stocks duplicated. As such if you are cherry picking funds from morningstar you need to look at their underlying benchmark index, and then look at the ratios that apply to it, such as Beta, Sharpe, Treynor, R-squared etc. These will give you a feeling for if the fund fits in your portfolio, and how well the fund in question represents its mission statement.

Frankly, I would not build portfolios with such funds. The building blocks of portfolios are index funds, these can be structured together and tilted strategically, and by doing so you can achieve investment goals at a lower cost.

You really shouldn't have a 'menagerie' of funds. It gets confusing, and you lose site of your exposure to market variables. While I can see portfolios of up to 10-12 funds making sense for some, many can do well with 4-5.

Personally, I hold a base position in broad indexes - such as total stock market, and then I tilt on areas of interest for my goals, such as healthcare and telco.

 

[PointsEarner615]

Some of those targeted funds can be just horrendous when it comes to fees. I had one through Voya (formerly ING) that was essentially a fund of index funds with a 1.5% expense ratio. Looking under the covers, the fund was also investing in hedge funds and other nonsense.

I'd agree with Matt that you can have too many index funds. I'm probably guilty of that right now having converted from a portfolio of country-specific funds and individual stocks to a more broadly diversified holder of international and domestic index funds, with a tilt to small cap and value.

I wouldn't worry about the recent declines. If you're coming anywhere close to an 8% compounded return, you're doing great.

 

[El Ingeniero]

Morningstar ratings are completely meaningless, IMO. Mutual fund companies start hundreds of funds every year, hoping one will get hot. The resulting stampede pretty much obliterates any chance the fund manager has of continuing previous performance.

 

[tmount]

Some of those targeted funds can be just horrendous when it comes to fees. I had one through Voya (formerly ING) that was essentially a fund of index funds with a 1.5% expense ratio. Looking under the covers, the fund was also investing in hedge funds and other nonsense.

I'd agree with Matt that you can have too many index funds. I'm probably guilty of that right now having converted from a portfolio of country-specific funds and individual stocks to a more broadly diversified holder of international and domestic index funds, with a tilt to small cap and value.

I wouldn't worry about the recent declines. If you're coming anywhere close to an 8% compounded return, you're doing great.

Thanks -- I'm no where near 8%, let alone double digits. I generally use Fidelity funds -- Fidelity has a nice little research tool that allows you to filter based on (1) desired returns (I think on a scale of 1-5), (2) Fees, (3) risk and (4) rating.

It sounds like the rating isn't terribly meaningful though?

 

[Matt]

Here's a little more on them:

http://saverocity.com/finance/can-read-morningstar-report/

 

[PNW-MSSER]

I wonder if one can take advantage of interest rates in other countries, India for example has 10% rates for fixed deposits, folks of Indian origins can invest easily but how easy/difficult is it for others ? Ofcourse there is always the currency risk.

 

[Matt]

I wonder if one can take advantage of interest rates in other countries, India for example has 10% rates for fixed deposits, folks of Indian origins can invest easily but how easy/difficult is it for others ? Ofcourse there is always the currency risk.

There's a lot more to consider than just currency risk. Using the notion of CAPM you will get a reward rate that is inline with all risks.

To make it more simple, if you found a place in Africa that offered a 50% interest rate, would you only be worried about exchange rates, or would you be also concerned about ability (and even desire) to repay? High interest rates on savings within an efficient market indicate that credit is tight, and premiums are demanded. It may also mean that you have inflation impacting the currency.

Consider:

1. FDIC insured, large bank CD (issued by Chase) 5yr rate might be 1.5% (arbitrarily here)
2. Non-FDIC insured, US quirky bank CD 5yr rate might be 3%
3. Non FDIC insured, high inflation risk country big bank CD 5yr rate might be 8%
4. No FDIC insured, high inflation risk country smaller banks CD 5yr rate might be 10%

There's a place for overseas investments in your portfolio, but you need to factor in many different moving pieces beyond simple currency risk. Recent examples have been Greece, Iceland and Russia for this.

Note if you do find a good deal, please make sure you are up to speed with FATCA and FBAR.

 

[PNW-MSSER]

There's a lot more to consider than just currency risk. Using the notion of CAPM you will get a reward rate that is inline with all risks.

To make it more simple, if you found a place in Africa that offered a 50% interest rate, would you only be worried about exchange rates, or would you be also concerned about ability (and even desire) to repay? High interest rates on savings within an efficient market indicate that credit is tight, and premiums are demanded. It may also mean that you have inflation impacting the currency.

There's a place for overseas investments in your portfolio, but you need to factor in many different moving pieces beyond simple currency risk. Recent examples have been Greece, Iceland and Russia for this.

I cannot speak of other economies, in India, these rates are due to inflation and credit being at a premium, lending rates are set by the central bank. Indian banks were well insulated during the subprime crisis due to stricter than usual regulations Indian banks have to adhere to especially for lending. I have invested in Indian banks(am of Indian origin) and have never had a bank default on me. Most banks have very small NPAs and would never give a loan to someone who is likely to default even at obscene rates.

Upto $2500 per bank in insured by the DICGC and Indian currency is backed by gold (guaranteed to pay equivalent) unlike the US currency (is just really debt) .

Yeah, but FBAR and FATCA are 2 things everyone needs to take care of unless you want the IRS knocking. Just my $.02

 

[Annie H.]

I know there are many folks smarter than I - have you encountered this type of situation? Are double digit returns a myth?

Don't assume those smarter folks are mutual fund managers.
Check out Bogleheads.org.; well worth your time. You'll find a lot of those smarter folks there.