April 14, 1998
Six
Opinions
The Fool on the Beardstown
Ladies
Honesty is
Admirable
by Louis Corrigan
([email protected])
I recently had the pleasure of returning to my high school to speak to students about my job at the Motley Fool. Sitting in front of a computer screen writing or sifting through posts, press releases, and public filings while CNBC plays in the background is not exactly a teenager's idea of a good time, though, so I figured I'd juice up my presentations with a dose of Foolish education on how to turn $2,000 into a million.
I convinced them that they could easily earn $2,000 lifeguarding and babysitting so they could utilize a ROTH IRA. Hey, I said, just save half of what you earn and then get your parents and relatives to chip in the rest.
Ruling out the lottery, we focused on three investment options: a CD returning a generous 6%, the Standard & Poor's 500 index returning 11%, or the Foolish Four returning 25%. How long would it take for each investment vehicle to work its magic? My confident answers were 82, 76, and 28 years, respectively. But as a certain hyperbolic hedge fund guy would say... WRONG!
It's quite embarrassing to have spent two hours trying to teach 100 teenagers how useful and cool it would be for them to get a grip on financial matters only to realize you'd been blowing bogus smoke at them all afternoon. They just might have shown those handy flyers to their parents, too, with somebody figuring out along the way that the reason the numbers didn't look right was because they weren't.
OK, my overall point about compounded interest and smart investing still holds up. My most important calculation also remains correct: at 25% a year, we get our million in just 28 years. But believe me, I feel like a complete dope. So much for running numbers while watching the Oscars! If there were an easy way to chase down those 100 students and give them the right numbers, I would. At 6%, for example, that $2,000 turns into $238,000 after 82 years. At 11%, the money becomes a much happier $5.57 million after 76 years. And at 25%, that babysitting money turns into an astonishing $342 million after 54 years, more than triple what I told them.
The Beardstown Ladies screwed up their numbers, actually generating a 9.1% annual return between 1984 and 1993 instead of the 23.4% they had claimed. And that was well below the 14.9% annual return produced by the S&P 500. That's a major goof and one well worth publicly correction, but it's not something that I'd want to snicker too much about.
Besides, the Ladies amply confessed their sin as soon as it was pointed out and confirmed. If to err is human, then to correct one's errors is Foolish. With no indications that the Ladies intended to deceive their readers, the most one can say is, "Gee, I wonder if my own record-keeping is any better." Clearly my math isn't!
Moreover, the Ladies have done even better of late, bringing their average annual return to about 15.3%, according to Price Waterhouse, just behind the S&P's 17.2% return over the same period. So the Ladies' performance still looks awfully competitive to that of the Wise. Which brings us to a final issue. While we Fools and Beardstown Ladies correct our misrepresentations, the Wise often don't.
Think about mutual funds. A fund's advertised performance includes distributions, but distributions are taxed. Due to the tax advantage of long-term capital gains, two funds with equal average annual returns may provide vastly different after-tax returns if one has 100% annual turnover in its investments while the other has just 35% turnover. Mutual fund print ads ignore this issue as if it actually has no bearing on the fund's return to investors.
Then there's the matter of comparing a mutual fund with some viable market metric like the S&P 500 or with other funds of its class. Mutual funds generally don't make such comparisons in ads unless the fund has clearly outperformed the market or its peer group. Indeed, it's common to see performance records highlighted with no mention of the fact that a fund actually underperformed the market.
Finally, there's the question of the real return any mutual fund investor can expect. Typically, fund companies start a new fund with a small amount of money. If the fund generates market-beating returns, the fund company will advertise it out the wazoo. In many instances, though, the fund begins underperforming the market shortly after investors start piling in. New funds with great records over 3- to 5-year periods have often generated most of their gains during the astonishing early run. Why don't funds identify the average fund holder's annualized returns over a given period? Wouldn't that be a more accurate measure of how well the fund is really doing for its shareholders?
Sure, these are not errors -- just institutionalized practices for which mutual fund companies will offer no apologies, issue no clarifications. Too bad. Honest accountability is something both commendable and surprisingly rare. The more the merrier.