What is an Actual Return?
An actual return refers to the actual gain or loss an investor experiences on an investment or in a portfolio. It is also referred to as the internal rate of return (IRR). It can greatly affect net worth.
The Basics of Actual Return
As opposed to expected or assumed returns, the actual return is what investors really receive from their investments. For example, a mutual fund's disclosure statement might say something like, “The securities of the Fund you invest in earn 5% each year, although the actual return will likely be different.” Analyzing the reasons for the discrepancy between expected and actual return figures helps in understanding the role systematic (the market’s) and idiosyncratic (the manager’s/fund’s) risk factors played in portfolio returns. Drivers of actual returns include trading costs, manager fees, investment timeframe, whether additional investments or withdrawals were added during the time period, as well as the impacts of taxes and inflation.
Both the Securities and Exchange Commission (SEC) and the Government Accountability Office (GAO) have studied and made proposals to require mutual fund companies to improve the disclosures they provide to investors and potential investors over the years. In a Final Rule, issued in February 2004, the SEC specifically mentioned the need for funds to distinguish between actual and expected returns. For example, a mutual fund describing and illustrating the cost and performance of a hypothetical investment over a five-year period would have to reference actual return numbers as well as actual cost figures.
- Actual return refers to the de facto gain or loss an investor receives or experiences on an investment or portfolio.
- Actual return can also refer to the performance of pension plan assets.
- The opposite of actual return is expected return.
Special Considerations: Actual Return and Pension Plan Assets
Actual return is also used to describe the performance of a company’s pension plan assets. In this case, it is referred to as “actual return on plan assets.” The actual return is compared to the expected return.
The formula for computing actual return for pension plan assets is:
Ending Balance (fair value) – Beginning balance (fair value) + Benefits – Contributions
Since pension plan accounting rules allow employers (companies, governments, universities) to calculate assumed rates of return for their pension obligations, they do not reflect employers’ actual obligations to current and future retirees. Because expected returns are often based on optimistic assumptions, they tend to understate obligations and overstate a company’s financial position. While companies must provide a reconciliation of the two sets of numbers (actual return versus expected return) in the footnotes to their financial statements, proposals have been made to change reporting requirements to make it easier for readers to discern companies’ actual returns and obligations.
Real-World Example of Actual Return
In its May 27, 2019, Manulife RetirementPlus Fund Facts report, The Manufacturers Life Insurance Company described the performance of the various funds in its insurance contracts. Each breakdown has a section "How Has the Fund Performed?", with average returns and a chart indicating annual returns for that particular fund over the previous five years. In addition, each section had a disclaimer: "Your actual return will depend on the guarantee option and sales charge option you choose and on your personal tax situation."