The more volatile a fund's returns are, the more likely its investors won't enjoy the full returns of the fund. One example is Fairholme Fund (FAIRX). It's long been one of the top-performing large-cap value stock funds because of the high-conviction approach of its manager, Bruce Berkowitz. Fairholme typically invests in just a couple-dozen stocks, and in recent years invested heavily in financial services stocks, such as AIG and Bank of America.
The fund's performance has been extremely erratic the last two years: a 32 percent loss in 2011, followed by a nearly 36 percent gain last year. The rollercoaster ride hasn't been particularly good for investors, despite Fairholme's 10-year average annualized return of 11 percent through the end of January. Over that period, its investors averaged 3 percent, or nearly 8 percentage points less, according to Morningstar's calculations.
A DOSE OF DISCIPLINE
"The better you know yourself — what you're good at, and when you get emotional — the better you're likely to do as an investor," Kinnel says.
If you know you're prone to making rash short-term moves, it can be worthwhile to check how a fund's posted returns differed from the results investors experienced. If there was a sizable gap, it means the fund's investors have, on the whole, had poor timing. That could increase the chance that you won't fare well either.
To assess the gaps between a fund's past returns and its investors' results, click on the performance tab for individual funds listed on Morningstar's website. An "investor return" page provides data on the gaps.
How much of a gap is too big? There's no hard rule. One option is to consider that the average gap for all funds has been nearly a percentage point over the latest 10-year period. Anything larger than a percentage point gap in a fund's 10-year results may suggest some additional diligence is warranted.
Be careful, however, in reading too much into a fund's gap over just a few years. Cash flows in a given period can be affected by factors that have little to do with investors' decisions. Examples include a fund that closes to new investors for a period of time, or one that launches after a period when stocks have fallen sharply, and few investors are buying.
Says Kinnel: 'There can be quirks, so it's important to look at the big picture."
Questions? E-mail investorinsight(at)ap.org
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