One of the easiest ways to analyze a mutual fund is to look at its performance—this is an objective, easy-to-find, concise measure of how well the portfolio manager has done in choosing investments. This analysis is so common that nearly all investors recognize and trust the Morningstar ‘Star Rating’ in regards to how a mutual fund has performed relative to its peers. However, mutual fund returns can be presented and viewed in different (sometimes deceiving) ways; this guide will show you what to look for and how to accurately analyze mutual fund returns.
With or Without Dividends?
Mutual funds (and other investment vehicles or services) often compare their performance to that of a broad market index, such as the S&P 500 Index. However, to be accurate, make sure that both of the compared returns are calculated in the same manner, i.e., don’t compare the combined capital gains and dividend return of a mutual fund to solely the capital gains of the S&P 500 since you will leave out the very valuable dividend component. CNBC host Jim Cramer’s investment newsletter/portfolio, Action Alerts PLUS (AAP), just got caught making this mistake by the Wall Street Journal. A promotional e-mail claimed that the AAP portfolio beat the S&P 500 by nearly 24% since 2002; however, the AAP portfolio included dividends, while the S&P 500 returns excluded dividends. When the performance was accurately compared, the AAP portfolio only beat the S&P 500 by less than a percentage point.
When evaluating the long-term performance of a mutual fund, make sure you see how the fund has performed over time periods other than what is typically presented in marketing materials. For example, the most common performance periods are 1-year, 3-year, 5-year and 10-year. Consider the case of a 4-year old fund that only reports 1-year and 3-year performance. The first year of operations could have seen the fund drop in value by 50%, only to recover and post good performance for three years; however, many investors may miss this valuable information if they only view the most commonly listed performance figures. If the fund you are analyzing has been around for a couple decades, it may be a good idea to view rolling 5-, 10-, and 15-year averages to get a good picture of how the average changes over time.
By making sure that the returns you are evaluating are accurately presented and that the time period chosen is unbiased, you will be able to get a clear view of a mutual fund performance. Armed with this knowledge, you will be able to make much more informed decisions and find the mutual fund that is right for you.