Is Your High-Performing Mutual Fund Killing Your Portfolio?
You should be more concerned about a fund's volatility than its average annual return.

Mutual funds are the cornerstone of many investors' portfolios. Choosing the right one for your retirement plan can be complicated. There are thousands of mutual funds in the U.S. alone, holding trillions of dollars in assets.
With so many choices, how do you pick the right mutual funds for a successful investment strategy?
Consider this real-life example (names have been changed, of course, to protect confidentiality): Bob and Sally walked into my office looking for advice about mutual funds. They had narrowed their choices to two funds, but that's when it got tricky.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Each fund had the exact same average annual return over the past five years: 5.53%. They wondered, "Which one do we choose?"
You would think two funds with the same average annual return would produce the same amount of money, right?
Let's take a closer look. Here's a chart showing a side-by-side comparison of the two funds' rates of return.
Over the past five years, the holdings in Fund A produced big returns (nearly twice as big as Fund B's gains) four out of five years with one bad year. The five-year average annual return was 5.53%.
The five-year average annual return of Fund B was also 5.53%. It posted lower returns than Fund A four out of five years and recorded a smaller loss in Year 2.
Okay, so which one should Bob and Sally choose?
The answer is Fund B. Emphatically. It's not even close, and here's why:
With $500,000 invested in each fund, and with an average return of 5.53% a year, Fund A earned $69,477.
Mutual Fund B earned $143,357.
That's an eye-popping difference of $73,880!
What's going on here? Volatility. It's all about the volatility within a mutual fund. The fund with the least amount of volatility produced more cash over five years.
People generally think rate of return is the most important factor to a fund's success. But the truth is volatility is a bigger factor.
For example, if a mutual fund drops 25% one year, then you need a 33% increase just to break even. Bigger losses require even bigger gains—a 50% drop needs a 100% increase to get back to even.
Bob and Sally's example serves as an important heads-up if you're buying in the current market, now at historic highs, because volatility in a dramatic downturn could translate into significantly less money for your portfolio over a period of years.
This lesson raises a key question: Why do we accept higher risk, and volatility, in our personal portfolios?
It goes back to the basic investment principle that we're all led to believe: take the higher return to earn more money; accept more risk for more return.
But that's not necessarily the right choice. Mutual funds experiencing big fluctuations like the one above—Fund A with a 37% drop in one year—are detrimental to your portfolio. That's an eye-opening lesson.
Reducing Volatility
Apply the same principle to your own investment portfolio. Can you reduce volatility in your portfolio through smart asset allocation? Make sure your portfolio is not weighted too heavily with one type of fund. That strategy will better protect you from big market downturns.
You'd be surprised by the number of investors walking into my office who firmly believe their portfolio has low volatility like our Fund B, but a closer look reveals they actually own something closer to Fund A. About 70% discover they have too much volatility.
One other thing to consider: Many people buy passively managed mutual funds because they charge lower fees. Low fees mean low turnover in the fund; managers are not trading much.
That strategy is great for a rising market, but in a year like 2016 with lots of ups and downs, you want your portfolio to have more flexibility so you can adjust them during market fluctuations.
Giving managers the option to grab discounts, or sell poor performers, could reduce volatility and put your portfolio in a better position over the long term. Not making changes can cost you.
Now you're better prepared to put together a winning retirement portfolio. You understand it's more important to evaluate the volatility in a fund rather than its average rate of return.
That's a valuable lesson whether you're in your 40s or 50s, or nearing retirement like Bob and Sally.
Talk to an investment adviser about performing a full analysis on your mutual funds. It will reveal whether volatility in your high-performing mutual fund is actually killing your portfolio, and if you need to adjust your game plan.
Reid Johnson is president and founder of Lake Point Advisory Group LLC, outside of Dallas, Texas. He is an Investment Adviser Representative and insurance professional. His personal mission is to help people achieve financial security so they're comfortable in retirement.
Dave Heller contributed to this article.
Disclaimer
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
Reid Johnson, TX license 1068067, is president and founder of Texas-based Lake Point Advisory Group, LLC (www.lakepointadvisorygroup.com). As a financial professional and fiduciary when providing financial advice, he is dedicated to providing his clients with the individual attention necessary to help them pursue their financial goals. He has contributed to various media sites, including Wall Street Select, CNN and The Star-Telegram.
-
Stock Market Today: Dow Rises 854 Points From Its Intraday Low
If there's one thing markets hate, it's uncertainty. But uncertainty is all they're getting these days.
By David Dittman Published
-
Are You a Retirement Millionaire Too Scared To Spend?
If you are too scared to spend money in retirement, you may be saddled with regret. Here are three ways to safely enjoy your sizable retirement nest egg.
By Donna Fuscaldo Published
-
Seven Questions to Ask When Evaluating Personal Loan Options
Taking out a personal loan too hastily could lock you into unfavorable terms with an untrustworthy lender. Ask these questions before signing anything.
By David Kimball Published
-
The Three Biggest Fears Keeping Retirees Up at Night
Here are the steps you can take to put those fears to rest and retire with confidence so you can relax and enjoy the life you've planned.
By Pam Krueger Published
-
What Can a Donor-Advised Fund Do for You? (A Lot)
DAFs and private foundations go about helping charities (and those who donate) in different ways. Each comes with its own benefits and restrictions to navigate.
By Julia Chu Published
-
Estate Planning When You Have International Assets
Estate planning gets tricky when you have assets and/or beneficiaries outside the U.S. To avoid costly inheritance mistakes, it pays to understand the basics.
By Kelsey M. Simasko, Esq. Published
-
Three Essential Estate Planning Steps to Protect Your Nest Egg
After dedicating years to building your wealth and securing your future, make sure your assets are protected and your loved ones are provided for in the future.
By Nicole Farbo, CFP® Published
-
Is Chasing the American Dream Ruining Your Financial Life?
Too many people focus on visible affluence as a marker of success. Here's how to avoid succumbing to the pressure and driving yourself into debt.
By Anthony Martin Published
-
Retiring With a Pension? Four Things to Know
The road to a secure retirement is slightly more intricate for people with pensions. Here are four key issues to consider to make the most out of yours.
By Joe F. Schmitz Jr., CFP®, ChFC® Published
-
How to Teach Your Kids About the Tax Facts of Life
Taxes are unavoidable, so it's important to teach children what to expect. Also, does your child need to file a tax return for 2024? Find out here.
By Neale Godfrey, Financial Literacy Expert Published