Investment Returns - Why assumptions are important

I am sure that you have heard the saying 'there are lies, damn lies and statistics'.  As Wikipedia eloquently says:

Lies, damned lies, and statistics" is a phrase describing the persuasive power of numbers, particularly the use of statistics to bolster weak arguments.

One of the things that annoys me most about investment advertising is when the graphics or comparisons don't state what the assumptions are behind the stated investment returns.  Unfortunately, this practice also extends to journalists articles and associated graphics and sometimes to investment statements and brochures.

Like apples and oranges, you need to ensure that you are comparing the same thing before you draw any conclusions.  There are many ways that investment return statistics can be used to 'persuade' by comparing apples and oranges.

What are the key assumptions that you need to know about when you are comparing investment return claims?

1.  What is the role of Tax, Inflation, Fees?

Fees: Are the returns before or after fees?  If the assumptions say that they are after fees - which fees?  The investment managers fees?  It is normal practice to quote investment returns in Australia and New Zealand after investment manager fees.  But does this include any performance fees?  What about financial adviser fees?  Are they paid out of the investment manager fees (this is the norm in KiwiSaver) or are they charged in addition (this is the norm in an advised portfolio on an investment WRAP platform).  How much are the adviser fees?

Taxes: Historically in New Zealand, investment returns were quoted AFTER TAX.  However, on 1st October 2007, when the PIE/PIR tax regime began, investment returns for PIEs are now traditionally quoted before tax.  Are you comparing an after tax number with a pre-tax number?  What tax rate was used?  Is that the same tax rate that applies to you?  This change makes it extremely difficult to compare investment returns pre 1 October 2007 and after that date.

Inflation: Inflation is the silent thief that takes away your purchasing power.  At Moneyworks, when we are doing our planning for clients retirement, and when we are teaching our clients how to plan for the future, we always use after fees, tax and inflation numbers.  We have to make an assumption about inflation, but this means that we are comparing future dollars with today spending (putting the expenditure and assets into today dollars.) Advertised Investment returns rarely incorporate this adjustment.

2. What dates are you comparing?

It is vital that the dates that you are comparing are EXACTLY the same.  I have had several situations over the last 20 years where I am been asked to comment on investment returns to say the 28th February, when all the other information available is only available to the 31st March, or 31st December.  This is particularly so with 'private' type offerings and offerings from organisations such as Medical Assurance (who I believe are gradually changing to a unitised basis, so that their returns can be quoted more than twice a year.)

Even one day makes a difference.  To give an example. The following are returns for the last 12 months for a clients balanced portfolio where they are not making any regular investments.

12 months return to 30th  June 201512 months return to 1st July 201512 months return to 13th July 2015
Balanced PortfolioReturns after managers fees, but before tax, adviser fees and inflation





As you can see, even with one days difference, there is a difference in return.  It is vital that you compare exactly the same dates and exactly the same time period.

3. Have regular contributions been made to the investment or was there just a lump sum at the start of the year?

When you are making regular contributions (like most people do to KiwiSaver), this will affect your return.  This is because if you only had say $10,000 invested at the start of the year, then it is easy to work out the investment return, as it will be the increase in value at the end of the year.

But if you start off with $10,000 and add $1,000 each month, then from month 2 there was $11,000 invested, from month 3 there was $12,000 invested and so on.  You need to use the appropriate formula to correctly calculate the investment return on each different balance between that date and the end of the year that you are looking at.

At Moneyworks, we purchase specific software that enables us to produce these reports for our clients KiwiSaver investments.

It is important to make sure that you don't compare investment returns where there are no regular contributions with your actual investment returns if you are making regular investments.

4. What is your risk profile?

There are five main risk profiles that are used in the investment world.  Increasing in risk they are: Defensive, Conservative, Balanced, Growth and Aggressive.

Each of these risk profiles will have a long term benchmark for each main asset: Cash, Fixed Interest, Property, Australasian equities (shares) and International Equities.  As each of these assets gives different returns in different markets, you need to ensure that you are comparing the same risk profile.

Even then, within 'balanced' funds as an example, with the main KiwiSaver Balanced Funds that we monitor, the current allocation to 'growth assets' (Property and Equities) ranges from around 54% up to 69.3%.  So even though they are all 'Balanced' Funds by label, they can't be accurately compared to each other as the fund with 69.3% growth assets will have significantly more risk than the fund with around 54% of growth assets.

It is important that you know what the asset allocation of the investment portfolios are that you are comparing.  And, if the asset allocation of one portfolio has changed more than once during the year, and you are comparing it with say a 50/50 portfolio, you will get nonsensical information.

5. Artificially constructed numbers

Possibly my biggest gripe is reserved for organisations that present information that I will politely call 'artificially constructed'.  These numbers are presented for clients to compare against their existing returns.  However, unless people know how to compare information, it is very easy to not notice, or not understand the importance of the assumptions.

Here is an example of the wording of the assumptions in the small print of one firms website (with identifying information removed):

"Disclosures: All returns are net of management fees, but before adviser monitoring and custodial fees.

All returns are gross of tax.

 asset allocations have changed over time. All returns are based on our current asset allocation model.

Returns are a combination of actual returns (where available) and simulated data using relevant benchmarks. All returns have been sourced from data that believes is accurate.

Past performance is not necessarily an indication of future performance. Individuals should obtain specific investment advice from a qualified adviser before making any investment decision."

The italicised information is the information that concerns me.  What this is saying is that if at present the portfolio has 5% in cash, 40% in fixed interest, 15% in property, 15% in Australia and New Zealand shares and 25% in international shares, then have used the actual returns on clients portfolios and simulated the returns back across all the data periods that returns are quoted for.

However, at the start of the year, the asset allocation may have been say  15% in cash, 45% in fixed interest, 5% in property, 15% in Australia and New Zealand shares and 20% in international shares,  In my opinion, this is a very misleading representation of what the investment manager is actually doing.

In addition, the numbers are quoted back for many years, providing an impression of longevity, when in reality a number of the investments that they are discussing have only been available for less than 10 years.  The rest of the time period are 'simulated' data.


It is vital that when you are doing comparisons of investments and investment returns yourself that you take all of this information into account.  Make sure that you know what the assumptions are saying and only compare like with like.  Otherwise, the information might as well be lies, damned lies or just 'pretty statistics'.

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