Analyzing performance figures and other metrics

Once you've decided whether a fund's objective, style, and strategy make it a good potential candidate for your portfolio, it's time to look at metrics that can help you determine how successful a fund is at achieving its goals, and what you might expect as an investor. Though past performance is no guarantee of future results, information on such metrics as returns, risks, volatility, and expenses can give you a basis for comparing one fund to another. Carefully consider not only a fund's returns, but also how it achieved those returns.

Tip: When evaluating a mutual fund's performance, make sure you're comparing it to an appropriate benchmark, or to funds that have similar investment objectives and that invest in similar securities. For example, comparing a large-cap stock fund to one that invests exclusively in small-cap stocks won't give an accurate picture of either one.

Some of the most popular metrics used to evaluate mutual funds include:

  • Performance/returns: The fund prospectus must include 1-, 5-, and 10-year (or life of fund) historical performance figures. It also must compare those figures to those of an appropriate benchmark index. Consider both short-term returns for specific time periods--for example, a bear market--and longer time periods. Considering only short-term results can be misleading (for example, if a fund's market segment, asset class, or investing style is temporarily out of favor). Also, be careful about what's known as "chasing performance"--investing in funds solely because they have recently experienced high returns. Those high returns can sometimes (though not always) mean a market sector may be at a peak and about to rotate out of favor, as all sectors do periodically. Consider how a fund has performed in both bull and bear markets. A fund must include in its prospectus its best and worst quarterly performance during the past 10 years.
  • Risks: Be sure you understand the various types of risk a given fund may face, such as market risk, interest rate risk, inflation risk, default risk, liquidity risk, currency risk, and political risk. All mutual funds face the same risks associated with their underlying securities. Understanding how a fund may be affected by such factors as a change in interest rates or fluctuating currency exchange rates can help you either be a better long-term investor or trade more effectively.
  • Fees and expenses: Because investing costs can have a substantial impact on your net returns--especially over time--you need to investigate how much you're paying to invest in a particular fund. Potential fees and expenses may include shareholder fees that you pay directly, such as sales charges or redemption fees, and operating expenses that are paid from fund assets and are thus an indirect cost. A fund's turnover rate can be used as an indicator of the level of a fund's trading expenses. Check a fund's expense ratio, which shows its annual costs as a percentage of its assets (remember that some types of funds often have higher expense ratios than others, so it's important to compare a fund to its peers). Find out if a fund has a required minimum initial investment, and whether there may be breakpoints that can help reduce sales charges.
  • Historical volatility: Though past performance is no guarantee of future results, you should also find out how volatile a fund is. Again, it's important to gauge a fund relative to an appropriate benchmark and/or comparable funds, since some asset classes and market segments have historically been more volatile than others. Some common metrics often used to gauge volatility include standard deviation (measures how much a fund's returns have deviated from time to time from its own average) and beta (measures the extent to which a fund's return is correlated with movements of the overall market).
  • Fund management: Statistics about a fund's returns in the past are less useful if they were not generated by the fund's current manager. Check on a fund manager's previous experience with the asset class or market segment in which the fund invests, and how long the manager has been at the fund.

Continue to the final part of this series, to learn more about analyzing tax considerations.


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