Understanding Mutual Fund Performance

In this article, we're going to provide an overview of the variables that can impact the performance of a mutual fund.  Then we're going to finish up with return on investment information for the top performing mutual fund categories, which allows for a benchmark comparison between fund types.

Benefits of Mutual Funds

Mutual funds are a great introduction to the stock or bond market.  When buying into a mutual fund, an investor is really purchasing a share in a portfolio of securities.  These can be stocks, bonds, or a combination of the two.  Purchasing a diverse portfolio of stocks allows the investor to reduce the investment's overall risk profile.

Minimizing Risk

When investing money in a company, as is the case when buying common stocks, the investment carries with it two risks.  The first risk comes from the company itself.  For example, the company might go out of business, or underperform relative to its peers.  When that happens, the price of the stock will fall.  Let's 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 (now owned by Sears).  This is one form of the company risk that investors inherited when they purchased shares of Kmart common stock.

Mutual funds can help minimize individual stock risk because they represent a mix or portfolio of stocks.

The second form of risk assumed by investors in both Kmart and Wal-Mart stock 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 macroeconomic factors such as interest rates and other variables that affect all companies equally.

Market risk might also be linked to world events, which can translate 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 Fund Performance

Just like common stocks, the performance of mutual funds is affected by these macroeconomic factors as well as investor sentiment.  Since mutual funds are portfolios of stocks, they can 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.

Fees and Loads

The problem with mutual funds is the investor is 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 costs is management fees.  The prospectus for the fund will outline how much the fees run for each mutual fund.  But that number can be deceiving too.

When analyzing a mutual fund, it's important to understand all of the fees charged, which fall into three categories:

  • 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.

(We have an entire article dedicated to mutual fund loads if anyone is interested in learning more about these fees.)

Example:  How Fees Impact Performance

Let's say the mutual fund indicates the fees are only 2.0%.  That does not sound like a lot of money, until you do the math and figure out the impact on an investment.  Let's assume Ann invested $10,000 in a mutual fund 10 years ago, and the market moved an average of 10.0% each year over that 10 year timeframe.  If her mutual fund was able to match the performance of the market, and not all of them can do this, then her average return was 8.0%, which is a 20% reduction in return on investment.

If Ann could have avoided paying fees, then she would have about $25,937 at the end of year 10.  But her fund performance was hurt by fees and that same investment at 8.0% is only worth $21,589 at the end of year 10, which means she paid $4,348 in fees over that timeframe.

Analyzing Mutual Fund Performance

Anyone that is planning to buy a mutual fund for the first time will need 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:  allows investors to analyze mutual funds by category, fees / loads, ratings, expenses, and performance (usually stated in terms of average annual return).
  • Information Views:  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.

The topic of analyzing mutual fund performance is discussed at length in our article:  Evaluating Mutual Funds.

Long and Short Term Performance

As promised, we're going to finish this article by providing benchmarks for 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 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. (August 2016)

Top Long-Term Mutual Fund Performers 2016

Fund Category 5-Year Return
Health 16.77%
Consumer Cyclical 12.30%
Consumer Defensive 12.21%
Real Estate 11.04%
Large Blend 10.63%
Technology 10.51%
Large Growth 10.45%
Industrials 10.28%
Utilities 10.03%
Large Value 10.02%

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 (August 2016):

Top Short-Term Mutual Fund Performers 2016

Fund Category 1-Year Return
Equity Precious Metals 92.96%
Commodities Precious Metals 19.06%
Real Estate 18.29%
Utilities 16.19%
Long Government 13.35%
Long-Term Bond 13.27%
Consumer Defensive 9.83%
High Yield Muni 9.49%
Latin America Stock 8.58%
Muni California Long 8.31%

 About the Author - Mutual Fund Performance (Last Reviewed on August 4, 2016)