rate of return calculation

coxwell

thanks for that but I am not sure what you are saying.

Is my IFA exagerating the performance or not ?

Aegis

coxwell wrote: »

thanks for that but I am not sure what you are saying.

Is my IFA exagerating the performance or not ?

If he's trying to include his commission as dividend payments, I'd argue that that could well be exaggerating the performance, yes. Performance should ideally include all relevant charges wherever possible.

However, it depends to some extent on what you and him are trying to achieve with this calculation.

bowlhead99

Charges and commissions are a cost to you of doing business, as you are not a stockbroker with direct access to deal in the market for yourself, and even if you did, you don't have the cash or the skills to build your own sufficiently diversified portfolio for the same money. If the fees can be avoided while still getting the same risk/reward, then great. But to a novice, often they can't.

If you just accept you will have to suck them up, you can move on to how the underlying assets performed. On that basis it is not always ridiculous or an exaggeration for the IFA to refer you to gross performance to justify the fees. Personally I would judge the overall investment on its return after all fees and charges (like XIRR gives you off your actual cash flows) but others would see some merit in looking at the gross return and arguing that the inevitable fees for being in the game are well worth it.

He might be saying look this manager achieved a 6% return by picking a suitable set of investments while the average basket of investments with that same risk profile only achieved a 3-4% return in that timeframe, he's outperformed by nearly double the market. It might not be a bad set of underlying investments at all.

Unfortunately the cost of building a fund around the investments and marketing it to you via an IFA to make you aware of it, and employing staff to select the investments in the first place and manage them on an ongoing basis costs 3% per annum. Net result is from the gross performance of 6, you only got back 3% net, which is lower than some cheap tracker funds, and no better than what you could have got for yourself with a risk free bank account.

But fundamentally, he might say, the manager was successful in getting a better underlying return than the market and in a really good year he may get you 12% against 6% in the market, which is worth paying for in those years and the manager is not a fundamentally bad choice. This is not a terrible argument. But what is missing is the data for other timeframes and market conditions where you would see what happens in a real bad year; clearly if he loses by double the market and still takes the same fees and commissions for constructing the portfolio and marketing, you will get a pretty poor return as an end investor.

For comparability with other funds or investment opportunities you see advertised, you can simply create dummy cashflow entries from those total return numbers, add some additional cashflows if needed for IFA advice on those products, stick them into XIRR and and see what you get. Also remember you could use after-tax cashflows in your data because your personal tax situation can make a difference to whether a product is suitable for you.

But remember that having this hindsight and access to total return data is a wonderful thing, and just because you can use it now to find a fund that outperformed yours, doesn't mean the IFA would have reasonably expected that other fund to outperform yours, or that it was more suitable for you if it had different risks.