(The difference between tax gain/loss and total return on a mutual fund.)
Have you ever looked at your account online and thought “This fund hasn’t done anything”? As an advisor, I hear this compliaint often. Sometimes (unfortunately) one particular investment has not provided return. But most often the fund has produced return and the problem is looking at incomplete information. Here is what usually happens…
You log into your brokerage account to check on how your investments are doing, so you head over to the unrealized gain/loss page. You spot ABC Bond Fund that you invested $10,000 in five years ago. Today the value of the fund is $9,900 and there is a big, red ($100) in the gain/loss column next to it. You think “how could I have lost money on a bond fund over the past five years?”
The answer is that you probably didn’t lose money, you are only looking at half of your total return equation. What you see on the gain/loss page is a calculation of the change in price. It is your appreciation in value, or the number you would put on your tax return as a capital gain (or loss). This is not your total return. You have also received income from that fund over the past five years. Income is reported on a 1099 to you every year and you report it with interest and dividends on your tax return. To calculate your total return in a fund, you have to add appreciation and income.
Price Appreciation + Income = Total Return
Why don’t you get any appreciation in the fund? For an investment like a bond fund, your expectation should be that most or all of the return will come in the form of income and not increase in price, just like on a bond. Below is an example of how it works.
- ABC is priced at $100 at the beginning of the month
- During the month, ABC accumulates $1 of income (per share)
- The price of ABC increases as income accumulates to $101 at the end of the month
- ABC pays you $1 cash at the end of the month
- After the income is paid out, the price of ABC goes back to $100
$0 Appreciation + $1 Income = $1 Total Return
What if you are automatically reinvesting income, shouldn’t you see appreciation then? Yes and no…here is what happens when you reinvest.
- You receive $1 of income
- Your broker automatically buys $1 of ABC at the post-payout price of $100
- You now own 1.01 shares of ABC at $100 per share → $101 value
Your total value in the fund has gone up from $100 to $101. If you were to compare what you originally invested in the fund to the value in the fund today, you can easily see your total return. But since you bought all shares (including the fractional share) for $100 per share, your cost basis is still $100, and your gain/loss is still zero. You will still receive a 1099 reporting $1 income to you at the end of the year. The formula is still $0 appreciation + $1 income = $1 Total Return.
Where do you find the total return for a fund? Now that you know the difference in terminology, look for the words ‘total return’, ‘annualized return’, or just ‘return’ and stay away from price charts, historical price spreadsheets, and gain/loss. A price chart only shows change appreciation and not total return. Also don’t use the “SEC yield” of a fund. That is a rate of income that you could receive in the future, it is not a historic return. For your specific personal return in a fund, you advisor will provide this information on your quarterly reports or by request between quarters.
– Sara L. Seely, CFA