Because fees and expenses reduce investment returns, “always consider what fees and expenses are included in the performance calculations,” the SEC states. “If fees and expenses are not included in the performance calculations, you should ask what fees and expenses were excluded and how they would have affected performance.”
Specifically, the SEC advises investors to consider:
- Fees and expenses. Fees eat into investment returns, the SEC reminds investors. Which expenses are included in the performance calculation and which are not? How would any excluded expenses affect the investment’s net returns?
- Investors’ financial circumstances, including how factors such as age, income, other investments, or debt affect their financial situation and risk tolerance. Investment presentations may not take these into account.
- Market and economic conditions. For example, an investment could perform differently in rising and falling interest rate environments.
- Methodology. How is performance calculated? “Factors such as how a performance calculation accounts for dividends and its assumptions about taxes and market and economic conditions are important to understanding performance calculations,” the SEC says.
The SEC also advises investors to evaluate the reliability of a performance claim by assessing:
- Performance guarantees, targets and projections. “It is virtually impossible to guarantee returns on investments that have market risk (e.g., stocks) because profitability may depend in part on future market forces,” the SEC says. “Performance targets and projections can also raise unrealistic expectations of future performance. Remember that targets and projections are hypothetical and do not reflect actual performance.”
- Back-testing. “If you receive back-tested performance, you should consider asking what actual, historical performance was,” the SEC advises.
- Past performance. Historical performance can’t predict future performance, the SEC reminds investors.
- Cherry-picking past performance. An example would be an ad showing one period of extraordinary performance with little or no disclosure of unusual circumstances around it, the SEC says.
- Benchmark performance. The performance of a benchmark may not reflect the deduction of the fees and expenses paid, which would reduce returns, the SEC points out.