As you check out new funds or check on your holdings this month, you might get what seems like a pleasant surprise — five-year returns are way up. Take that mutual fund performance with a grain of salt, though. With October 2013′s end, five-year returns are now completely rid of the horrific month of October 2008, and the numbers are soaring artificially.
To give you a sense of how crazy the gains in performance will appear, consider some of the Vanguard funds I regularly follow. Vanguard MidCap Value Index Fund’s (VMVIX) five-year return is jumping from 12.7% to 19.6%. Vanguard 500 Index Fund’s (VFINX) five-year return leaps from 9.9% to 15.0%. Among sector funds, Vanguard Precious Metals & Mining Fund (VGPMX) goes from a loss of 6.8% per annum over five years to a gain of 3.3%, and Vanguard REIT Index Fund’s (VGSIX) five-year return more than doubles from 6.2% to 15.5%. Vanguard International Explorer Fund (VINEX), which showed a 10.2% five-year return in September, now has a 17.4% gain.
On average, Vanguard’s diversified domestic equity funds will see a wholesale 5.2 percentage point increase in five-year returns. Does it matter? Sure. Take 500 Index: At 9.9%, an investor starting with $10,000 would have over $6,000 in gains after five years. But compound that $10,000 at 15.0%, and your gains explode to more than $10,100.
And it’s not as if three-year returns will give investors pause. Those numbers are also astronomical.
The bottom line in my book is that you simply can’t rely on point-in-time numbers to tell you how a fund (or any investment for that matter) has performed. You need to use rolling returns — which is something I highlight in my newsletter on a regular basis — to understand how the typical investor, rather than one who invested only at the beginning of the point-in-time period, has done. For the huge ‘gains’ in five-year returns, keep that salt shaker close at hand.
Senior Editor Dan Wiener and Editor/Research Director Jeffrey DeMaso publish The Independent Adviser for Vanguard Investors, a monthly newsletter that keeps abreast of recent developments at Vanguard, and the annual FFSA Independent Guide to the Vanguard Funds.