Mutual Funds: Comparing Funds
You have selected the types of mutual funds appropriate to your investment goals, time horizon, financial situation and
tolerance for risk. Now it is time to shop for specific funds to invest in.
Focus on the risk associated with a fund. Do not chase after the biggest returns and loose sight of risk.
The tips below often refer to a fund’s prospectus. The prospectus is the formal, written document about the mutual fund that is
filed with the SEC. It gives detailed financial information about the investment, fees and expenses, the fund’s manager, investment
objectives, risks associated with the fund and past performance.
You can get the prospectus immediately and for free from the
SEC’s web site. You can
also request a printed copy from the fund, or from a financial professional if you are using one. Reading it online is my first
choice because I can get the info immediately, without delay.
Past Performance
Even though advertisements, rankings and ratings focus on how well a fund has performed in the past,
do not focus on past
performance numbers when selecting a mutual fund. Past performance of a mutual fund is
not the most important
factor in evaluating and comparing funds.
The future is different than the past. This year’s top mutual fund can easily be next year’s below average fund.
Repeat after me once more:
Past performance is
NOT a reliable indicator of future performance.
Volatility of past returns, however, is a good indicator of a fund’s future volatility. (Volatility means the price and value
tend to fluctuate alot and often.)
Tips For Comparing Performance
There are lots of ways to compare performance of different funds. Focus on the following two numbers. In the prospectus, look at:
- Total return — measures increases and decreases in the value of the investment over time after
subtracting costs. Total return is near the front in the “Financial Highlights” section.
- Variation in total return over the years — The “Financial Highlights” show yearly total
return for the most recent 10-year period. Look at year-to-year changes in total return to see
how consistent and stable the fund’s returns have been. This gets you past the problem that one spectacular year
can make an impressive 10-year total return for a fund with many average years.
Compare Costs
Costs are important. Costs lower your return on investment. A fund with a sales load and high expenses has to perform better
than a low-cost fund just to stay even with the low-cost fund. Costs are so important, I created
an
entire page about costs.
Next: Understanding Costs
