How to Analyze a Mutual Fund

Learn how to analyze mutual funds and achieve better performance

Analyzing Mutual Fund Performance

If you want to analyze historical returns, you need to do it right. Past performance does not guarantee future results, but it matters when analyzing actively managed funds. However, many investors fall into the trap of chasing performance by buying the best-performing funds and selling the worst-performing ones.

Analyzing the Manager’s Tenure

If you’re impressed by a mutual fund’s return over 5 years and 10 years, it may be a mistake to buy shares of that fund if the manager has only been in charge for one year. This indicates that the previous manager was responsible for the long-term strong performance, but the new manager has not yet proven themselves.

Looking for Low Expense Ratios

Low expenses give the fund a good head start compared to similar funds with higher expense ratios. In other words, relatively high expenses are a drag on performance. For example, if both funds had gross returns (before expenses) of 10.00% in a given year, the first fund would have a net return (after expenses) to the investor of 9.50%, and the second fund would have a net return of 9.00%. Small savings can turn into significant savings over time.

Looking for Low Turnover Ratios

Turnover for a fund represents the percentage of securities that were replaced during the previous year. For example, if a mutual fund invested in 100 different stocks and replaced 50 of them throughout the year, the turnover rate would be 50%. Turnover is related to the expense ratio because relatively high trading translates into higher expenses, such as trading commissions and research costs.

Searching for Tax-Efficient Funds for Taxable Accounts

Low taxes usually translate to higher returns because you keep more of your money and earn interest on it while investing. Most investors have at least one tax-advantaged account, such as an IRA or 401(k) or 403(b) or pension fund, but if you have an individual or joint brokerage account, you generally want to find mutual funds that do not generate large tax burdens from dividends and capital gains.

Consider Index Funds

All the guidelines mentioned above for analyzing mutual funds primarily apply to selecting actively managed funds. However, the analysis process for index funds is almost unnecessary, primarily because index funds have low cost ratios and low turnover ratios, and the manager’s tenure is typically not a factor. When analyzing index funds, you should ensure that the cost ratio is low, as low costs are the primary advantage of this type of fund.

Disclaimer: The information on this site is provided for discussion purposes only and should not be interpreted as investment advice. In no way does this information constitute a recommendation to buy or sell securities.

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Sources:

S&P Dow Jones Indices. “SPIVA Statistics and Reports.” Accessed Feb. 5, 2021.

Source: https://www.thebalancemoney.com/how-to-analyze-a-mutual-fund-2466454