Mutual Fund Performance

Understanding the true performance of a mutual fund is a complicated subject.  In this publication, we're going to discuss some of the tools that are available to help you analyze information, and get a better feel for a mutual fund's performance.  We'll also talk about some of the other factors that can reduce an investor's return, and eat away at a fund's overall performance.

In addition to covering the above topics, we're also going to provide some information on the performance of several mutual fund sectors or categories.  This allows for a comparison between fund types.

Benefits of Mutual Funds

Mutual funds are a great introduction to the stock and / or bond market.  When you buy into a mutual fund, you are really purchasing a share in a portfolio of securities.  These can be stocks, bonds, or a combination of these investments.  Purchasing a diverse portfolio of stocks allows you to minimize the investment's overall risk profile.

Mutual Funds Help Minimize Risk

When you invest money in a company, as is the case when buying common stocks, your investment carries with it two risks.  The first risk comes from the company itself.  This is the risk that the company might go out of business, or under perform relative to its peers.  When that occurs, the price of the stock will fall.  Let us take a look at two companies that are essentially in the same business:  Kmart and Wal-Mart.

Each of these companies has their own strategy, but they are both vying for the same consumer dollar. Arguably, Wal-Mart is winning this contest, and Kmart's stock price is suffering.  This is one form of the company risk that investors took when they purchased shares of Kmart common stock.

Mutual funds can help minimize individual stock risk because you are buying a mix or portfolio of stocks.

The second form of risk assumed by investors in both Kmart and Wal-Mart is a more general market risk.  This is the risk that the entire stock market itself might go up (which is called a bull market) or fall (which is called a bear market).  Generally, this market risk is linked to more macro-economic factors such as interest rates.  These factors affect all companies equally.

Market risk might also be linked to world events, which can translated into pessimistic sentiments among investors.  For example, rising oil prices might make investors more pessimistic about the near term future.  Mutual funds cannot help the investor mitigate this type of risk.

Measuring Mutual Fund Performance

Just like common stocks, the performance of mutual funds is affected by these macro economic factors as well as investor sentiment.  Since mutual funds are portfolios of stocks, they minimize individual stock risk.  This makes mutual funds very attractive to investors that do not have enough money to create their own portfolio of stocks.

Mutual Fund Fees Hurt Performance

The problem with mutual funds is that you are paying someone else to manage the portfolio, and the fees charged can eat into the performance of the mutual fund itself.  One source of fees is the actively trading of stocks in the portfolio, and payment of the associated brokerage fees.  The second major source of mutual fund fees is the management fees themselves.  Usually the prospectus for the fund will tell you how much the fee runs for each mutual fund.  But that number can be deceiving.

When analyzing a mutual fund, you should always be aware of the fees charged.  These are commonly referred to as:

• Front-Loads - payments due when shares of the mutual fund are purchased, and usually stated in terms of a percentage of the investment.
• Back-Loads - payments due when shares of the mutual fund are sold, or redeemed.  These fees are usually stated in terms of a percentage of the investment.
• Expense Ratios - management fees paid to the fund's managers, which includes payment of their salaries and transaction costs associated with the trading of securities held in the fund.

If you're interested in learning more about these fees, we have an entire article dedicated to mutual fund loads.

Example - How Fees Impact Performance

Let's say that the mutual fund indicates the fees are only 2%.  That does not sound like a lot of money, until you start to do the math and figure out the impact on your investment.  Let's assume you invested $10,000 in a mutual fund 10 years ago, and that the market moved an average of 10% each year over that 10 year timeframe.  If your mutual fund was able to match the performance of the market, and not all of them can do this, then your average return was 8%.

If you could have avoided fees, then you would have about $25,937 at the end of year 10.  But the mutual funds performance was hurt by fees.  Your investment at 8% is only worth $21,589 at the end of year 10.  That means you paid $4,348 in fees over that timeframe.

Analyzing Mutual Fund Performance

If you're planning to buy a mutual fund for the first time, then you're going to have to open an account with a broker.  All full-service brokerage houses, such as Schwab, provide their clients with many tools to analyze the performance of mutual funds.  These tools include:

• Fund Screeners - which allow you to analyze mutual funds by category, fees / loads, ratings, expenses, and performance (usually stated in terms of average annual return).
• Information Views - this includes fees, pre-tax performance, average annual returns, risk analysis, and the size of the fund.
• Fund Comparisons - side by side comparisons of mutual funds with respect to data similar to the information views mentioned above.

If you're interest in learning more about fund performance measures, we've discussed the topic of analyzing mutual fund performance at length in our article on evaluating mutual funds.

Long and Short Term Performance of Mutual Funds

As promised, we're going to finish this article by providing you with a feel for some of the long and short-term performance of mutual funds, by fund category.

In this first table, we're providing a long-term performance view by listing out the top ten performing mutual fund categories over the last five years.  Ranking in the table below is based on the average annual return over the last five years. (April 2011)

Top Long-Term Mutual Fund Performers 2011

This second table provides a view of the short term mutual fund performance, by category.  Once again, ranking is based on the average return over the last twelve months (April 2011):

Top Short-Term Mutual Fund Performers 2011

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