How to Judge Mutual Fund Performance

What Is a Mutual Fund?

A mutual fund is a pool of money that invests in assets like stocks and bonds. The pool of money is divvied up into shares for investors to buy and sell. A mutual fund offers an efficient way to invest in a diversified portfolio and, as with any investment, choosing one or several mutual funds that meet your investment goals involves thorough research.

Below are the three steps to reviewing a mutual fund and deciding if it is the right choice for your portfolio.

Size Up the Investment Style

The first step is to classify the mutual fund to determine if it fits within your scope. For example, if you are seeking a mutual fund that provides steady income, a mid-cap value fund, which is growth-oriented, will probably leave you disappointed.

Investment styles can also be viewed in terms of growth or value, large or small companies, and passive or active investing.

It's not hard to determine a fund's investment style. A financial investment tracking website such as Morningstar has all of the basic facts and performance data, along with tools that further help you evaluate the fund. Using a mutual fund screener tool, such as the one provided by Morningstar, can help with this task.

Compare Performances

Next, review the historical performance data and compare your chosen mutual fund with a few of its peers. Morningstar ranks each fund's risk and historical returns against other funds within its universe so you can easily determine if a fund assumes a greater risk than average. The ideal balance between the two, the risk and the returns depends, again, on your risk tolerance and investment objectives.

Dig deeper into the historical performance numbers to determine the consistency of the fund's returns. Do the five-year average returns look great because of one phenomenal year that could have just been luck?

Try to select a fund that consistently outperforms its benchmark and one that has withstood a few market downturns. These numbers likely illustrate the superior abilities of the mutual fund managers. Sometimes, however, when the market crashes, not even the best managers can save a portfolio from a loss. For this reason, also compare the fund's upside and downside data against comparable funds.

Key Takeaways

  • Mutual funds are large pools of money that invest in assets like stocks and bonds.
  • The first step in selecting a fund is to determine the investing style and determine if it suits your objectives.
  • It is also a good idea to scrutinize the performance of a fund over many years and look for consistency in returns.
  • Comparing a mutual fund to its peers gives a better sense about relative performance and fees.

Measure the Mutual Fund Fees

Finally, take a look into the fund's expenses and fee structure. Tactical mutual funds that have heavy trading or are very actively managed have higher annual expenses. Factor in these costs as they directly affect the real rate of return you receive.

While a fund that charges higher management fees is not necessarily better or worse, you should still be cognizant of a reasonable expense ratio for the type of fund you choose. Again, comparing the fees of one mutual fund with its peers can help to determine if the fund is right for your portfolio.

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