Your Mutual Fund: A Raspberry or a Tomato?

SCRABBLE PLAYERS

Do you know the word CWM? It means circus. Is there any other word in English with NO vowels (considering that Y, like ketchup, is both a fruit and a vegetable)?

FOOD ENTHUSIASTS (and Marketing Majors)

There’s a delicious new food on the shelves – dried plums. But don’t eat too many at one time.

SURVIVAL TIP

Every household should have a case or two of peanut butter under the bed. It outlasts any earthquake, hurricane, tornado, flood, or power outage; can be flung with deadly accuracy to stun but not kill an intruder; and provides a life-sustaining 6600 calories per 40-ounce container. It even floats. (Get the extra-chunky kind to have something to do while you’re waiting for the electricity to go back on – you can count the chunks.) For fluid and spice, you would want several cases of V8, which, like CWM, has no vowels but is both a fruit and a vegetable juice.

ACTIVELY MANAGED MUTUAL FUNDS: WORSE THAN YOU THOUGHT?

Morningstar reports that in the 20 years ended December 31, 2001 (not up to date because I have been carrying this WSJ clipping around with me for years, and it just out of my pocket along with two 34-cent stamps and a gum wrapper) U.S. stock funds returned an average compounded annual return of 13.8%. (Remember, even though the decline was well under way by then, this particular two-decade stretch was one of the best in history.) The Wilshire 5,000 index was up 14.3% over the same period, which proves for the umpteenth time the obvious: that on average, mutual funds will do worse than average (worse, that is, than the broad market indexes) because, unlike the indexes, their performance is weighted down by fees and expenses.

Ah, but this 13.8% was only for the funds in existence at the end of 2001. And mutual fund families have a habit of shutting down or merging their worst performers, never their best. It turns out that if you adjust the numbers for the rotten funds that disappeared along the way, the return was not 13.8%, but 12.7%.

Why the big gap between the 14.3% compounded return of the index and the 12.7% return of the funds? Fees and expenses, which probably did come to something very like the 1.6% annual shortfall. (Add in the tax-disadvantages of actively managed funds, and the upfront sales charges of load funds, and the performance gap gets considerably wider still.)

And just in case you thought a 1.6% performance gap was trivial, two points of reference: First, it seems less important when it’s chipped off of 14.3% than it would if it were chipped off of, say, 6%, leaving you just 4.4%. Second, $10,000 growing at 14.3% (to go back to that dreamy and unrealistic number) for 40 years compounds to $2.1 million. At 12.7%, thanks to the active management you were paying for, and assuming no sales fees or tax disadvantages, to $1.2 million. So except for the dyslexic, this really matters. (At 6% versus 4.4% both numbers are lower, but the difference no less dramatic: $103,000 versus $56,000.)

Tomorrow: Your Thoughtful Santorum Feedback, Complete with Management Tips and the Age of Consent in Albania