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:

 

important info! 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.