Imagine a fund that boasts a jaw-dropping 35% annual yield. Sounds like a dream come true, right? Who wouldn’t want their money to “work that hard?”
But then you dig a little deeper and notice something odd: the total return of the fund — how much your investment is actually growing — is only 20%.
Wait… if I’m receiving 35% in income, shouldn’t I be up 35% on my investment?
Not quite.
Welcome to the world of destructive return of capital — a quiet performance killer that can easily fool unsuspecting investors chasing yield.
What Is Destructive Return of Capital?
At its core, destructive return of capital means the fund is returning your own money to you and calling it “income.” That’s not a reward on your investment — it’s a refund of your investment.
Let’s give it a name: D-ROC.
D-ROC = Destructive Return of Capital, where distributions are so large they erode the fund’s net asset value (NAV) and leave investors poorer, not richer.
Here’s what it looks like in real life:
- You invest $10,000 in a fund.
- The fund pays you $3,500 over the year in “distributions.”
- But your account is now worth only $8,500, or 15% less than the initial investment.
So what really happened?
- You got back $3,500, which may have included $2,000 of real income or gains…
- And $1,500 of your own money was simply handed back to you.
Where Did the Other 15% Go?
Let’s break it down:
- 20% Total Return means your investment actually grew by $2,000.
- 35% Distribution means you received $3,500 in payouts.
- That 15% gap was filled by the fund returning your capital to you.
It’s like taking a loan from your future self. The more you withdraw, the smaller your base becomes. And eventually, you’re just cannibalizing your own portfolio.
That’s D-ROC in action — and it’s one of the most dangerous illusions in yield-focused investing.
The Hidden Cost: Taxes and Fees on Your Own Money
Here’s the insidious part most investors miss:
D-ROC isn’t just a return of your money — it’s a return of your money that comes with a tax bill and a management fee.
When you receive destructive return of capital labeled as income:
- You may pay taxes on a distribution that isn’t income at all.
- You may pay fund fees on assets that are simply being handed back to you.
- And you may even reinvest that money back into the same fund, triggering a rinse-and-repeat erosion cycle.
In effect, your capital is being shuffled from your right pocket to your left — while the fund takes a cut and the IRS follows close behind.
Not All Return of Capital Is Bad: Enter C-ROC
To be clear, not all return of capital is destructive. There’s a healthier version too — and it deserves its own label.
C-ROC = Constructive Return of Capital, where the fund returns a portion of your investment as part of a tax-efficient strategy without shrinking NAV or impairing long-term returns.
For example:
- A fund may sell appreciated positions and return part of those gains in a tax-efficient way.
- Or it may manage distributions over time to smooth volatility and minimize taxes — even if some of that is classified as ROC.
C-ROC is a tool. D-ROC is a warning sign. The difference comes down to whether NAV and total return are being preserved or eroded.
Why D-ROC Matters
High yields sound amazing, but if they come with a shrinking NAV, you’re not making money — you’re slowly bleeding it.
Here’s what D-ROC typically leads to:
- ❌ Eroded principal
- ❌ Reduced future income-generating potential
- ❌ False sense of performance
- ❌ Masked underlying underperformance
- ❌ Taxes and fees on your own money
In short: It’s financial sleight of hand. And it can go unnoticed until it’s too late.
What to Look for Instead
If you’re income-focused, don’t just ask: “How big is the yield?” Ask:
- Where is that yield coming from?
- Is the fund generating real income through dividends, interest, or trading gains?
- Or is it handing back your own capital and calling it a payout?
The D-ROC vs. C-ROC Test: A Simple 3-Step Check
Want to know if a fund is paying you real income — or your own money back? Try this:
- Look up the fund’s total return over the past 12 months.
- Compare it to the distribution the fund advertises.
- Ask yourself:
- If total return is equal to or higher than the yield, the income is likely legitimate or tax-efficient — think C-ROC.
- If total return is far lower than the yield, and NAV is shrinking, it’s likely you’re seeing D-ROC in action.
Example:
- Fund advertises a 35% yield
- But shows only a 20% total return
- That 15% gap? That’s not income. That’s a return of your own capital — minus fees and taxes.
Bottom Line
A 35% yield with a 20% return isn’t a windfall — it’s wealth in reverse. Real income is earned, not engineered.
So next time a fund offers something that seems too good to be true — especially in a world where interest rates are 5% — dig a little deeper.
Because the only thing more dangerous than missing out on yield… is destroying your capital, paying a fee for it, and getting taxed along the way.
Disclosure:
This newsletter is for informational and educational purposes only and is not intended to be investment advice or a recommendation to buy or sell any security. Examples provided are hypothetical and for illustrative purposes only; they do not represent actual performance or outcomes. Actual results may differ based on individual circumstances, investment strategies, and market conditions. Views expressed reflect TappAlpha’s perspective at the time of publication and are subject to change. Past performance is not indicative of future results. All investments carry risk, including loss of principal. Please consult your financial or tax advisor before making investment decisions. Tax consequences depend on individual circumstances.
