How to Compare Mutual Fund Performance

Mutual funds are a very effective way for small investors to get exposure to financial markets. Rather than investing in individual equities and bonds, a mutual fund investor gets access to a diversified portfolio of securities at a low cost. With diversification in place, a mutual fund allows you to form an effective investment strategy with significant upside potential in terms of capital growth, and dividend income, while having low risk. If you’re not the stock picking type, then mutual funds can be your vehicle of choice for long term investments. However, if you want to think about investing in mutual funds, you need to do a good amount of research as there are plenty of mutual funds available in the market. You will have to focus and understand the key mutual fund performance metrics in order to pick which fund is suitable to your needs and investment objectives.

Let’s look at the various factors you should consider while comparing the performance of various mutual funds:

Past Performance (Fund Returns)

While checking the performance of a mutual fund, the most common information you will come across is the past performance of the mutual fund. For most funds, the past performance is specified in terms of returns over the past 1-, 3-, 5, and 10-years. For a single fund itself, the returns over different time periods can vary drastically. However, with a long-term investment goal in mind, you should consider the 5-year or 10-year returns as a yardstick for real returns. A fund that has good positive returns over a long-term horizon tells us that the fund has an overall positive track record, even if the fund did badly in a particular year.

The returns of a fund are expressed as total returns of the fund. The total returns include the change in the net asset value of the fund, dividend distributions and any distribution of capital gains over a given time horizon.

Comparing the investment returns is definitely an important consideration. However, it is also important to analyse other factors including the fundamental characteristics of the fund and its underlying portfolio.

Fund Expenses

Once you’re satisfied with the returns performance of the fund, the next thing to look at is the expense ratio of the fund, which is expressed as a percentage of the total assets under management. The expense ratio refers to the total cost to an investor for owning the shares in the mutual fund. This is the cost that the investment company incurs for operating the fund, and includes various costs such as fees paid to the fund managers, administrative costs, taxes, accounting costs, etc. The expense ratio does not include sales fees and other redemption charges that are levied at the time of sale/purchase of fund shares. However, some funds do add a marketing expense to their operating cost, which is referred to as the 12b-1 fee. This is included in the calculation of expense ratio.

Before investing, an investor must carefully look at its expense ratio. The total returns of the funds are expressed net of the fund’s expenses. So, the higher the expense ratio, the more it eats into the total returns of the fund. So, if a fund is earning total returns of 12% but has an expense ratio of 2.5%, you actually earned only 9.5%. The expense ratio can vary widely across funds and generally ranges from 0.25% to 2.50% or higher.

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