subject: Investment Funds And Stated Rates of Return [print this page] Investment Funds And Stated Rates of Return
Investments are often graded via something called the "rate of return". From the rate of return one can calculate how much the investment makes on the dollar after a certain amount of time. For example, an investor puts $100 into a savings account which has an annual rate of return of 3%. After one year, the investor expects to get $103. Of course, the investor may have opted to withdraw from the investment much earlier, which usually means some reduced return as prorated by the length of the investment.
However, the fixed rate of return for CDs and savings accounts is somewhat of a special feature. Many other types of investments such as stocks, bonds, high yield mutual funds do not have fixed rates. An investor who invests $100 into the stock market does not expect to get a guaranteed amount back over any time period. In fact, it is almost as likely that the stock has lost some money. This is true for many government bonds that fluctuate in base value even though government bonds pay out money at a bond rate.
Mutual funds behave similarly to stocks as each fund is a compilation of several kinds of stock. The return of the mutual fund will go up and down in the same way that its component stocks fluctuate. Given this information, some investors may finally understand why financial companies keep advertising "mutual fund rates". Some companies even broadcast that they offer high yield mutual funds, but the definition of high yield mutual fund is unclear.
Mutual fund rates are a way for mutual fund companies to advertise their products. However, the rates are really "historical rates of return" which mean that they show how the mutual fund gained in value over time, but do not indicate any future behavior for the fund in question. Mutual fund companies like to advertise these rates to make the consumer feel more secure, but there will always be a disclaimer at the bottom of these advertisements that say the "historical rates" are not expected to hold in the future.
The source of fluctuations for mutual funds from year to year is derived from two reasons. One is that the underlying securities or the component securities of a mutual fund go up and down all the time depending on the fortunes of a company, the activity of the sector to which the company belongs, or to general condition of the economy as a whole. Another is that the companies included in the mutual fund sometimes pay dividends to its shareholders. In this way mutual funds can gain value even though the stock is lackluster.
Consumers of investment products such as real estate, stock and GNMA mutual funds should always remember that mutual fund rates reflect the past and not the future. High yield mutual funds and products advertised as such should be interpreted in the right way.
