Getting Started With Evaluating Mutual Fund Performance

When it comes to mutual fund investing, many people ask me how to evaluate the performance and quality of their mutual funds in their brokerage account, 401(k) IRAs, etc. Simply evaluating performance in terms of rates of return can be disappointing in our current environment; additionally, it doesn’t speak to an overall investment philosophy or guideline that you can refer to when times are tough. Therefore, when I help clients with their mutual fund investing, I use these four guidelines to help them decide how to move forward when building their investment portfolio: Load Structure. When mutual funds first became popular in the 1980s, you had to go through a broker to purchase them. You paid the broker through a front or rear load on the mutual fund so that s/he would service the account and help you from time to time. Although there are many great fund families where you still pay a load, as well as many great brokers and planners whom you compensate by investing with them in a loaded fund, the do-it-yourselfers of the world don’t need to mess with loaded funds because there are plenty of no-load options that still provide great long-term performance. Therefore you need to verify exactly what you are paying, and decide what your “load philosophy” is going forward. An easy way to do this is to simply look up your mutual fund using its’ ticker symbol at a site like Morningstar—in this example, I looked up AGTHX, American Growth Fund of America so you can see where to tell if the fund is loaded (you’ll see in the photo that it has a 5.75% front load—meaning of every $100 you invest, $5.75 goes to paying the person who sold you the fund). Internal Fund Expenses. In addition to the load you might be paying, you’re also paying internal expenses that go toward the operation and management of the specific mutual fund. Without going into all of the different types of mutual funds, the general principle is that you tend to pay more for an active portfolio manager monitoring a mutual fund, and you tend to pay less for a fund with a passive investing strategy, such as an index fund. One type isn’t necessarily better than the other, but again, I believe that a general guideline for what you’re willing to pay is reasonable—for example, most of my clients tend to stay at 1% or below. You can check and see how much your mutual fund is charging you, typically under the heading of “Expenses” on the fund fact sheet. Asset Class. Asset class simply refers to what “flavor” of mutual fund you’re purchasing, and all of them are initially categorized by the size of the company and phase of growth. Ideally, small, medium and large companies would move differently—if one class is up, another would be down, and so on. We can’t control that, but diversification is still important, which is why I encourage people to make sure they spread out their investments over multiple asset classes, which they can check for by looking at the individual fund’s style box. One mistake I see often is that someone has invested in multiple mutual funds—perhaps in their 401(k)—but the underlying holdings are identical. Every fund will tell you what their Top Holdings are, so you need to compare and make sure your funds aren’t in 3 different funds with identical holdings! You’ll see below I compared two American Funds, and both of them have Apple and tobacco companies, so they may not be the best funds to hold together if you’re looking for diversification. Benchmark. The final checkpoint for evaluating your mutual fund is to compare it to other similar entities—every single asset class has a corresponding index, which you can use to see how the overall asset class is performing, and then see how your individual mutual fund is holding up against that benchmark. Often when you pull up your mutual fund’s information, a benchmark is already provided for comparison. The question they are answering with the below chart is, if you invested $10,000, how has the benchmark and your mutual fund performed over the same timeframe? As you can see, this specific mutual fund (blue) did better than its benchmark (orange) during the 10-year timeframe. Although, if it even simply held even with the benchmark, I would still be satisfied . . . it’s only when you can see consistent performance below the benchmark that you need to look at making a change. When it comes to mutual fund investing and evaluating performance, the multitude of criteria can become very confusing very quickly--and there is A LOT here that I haven't mentioned that sophisticated investors may factor into their evaluation process. However, many people lose sight of what they are trying to accomplish when confronted with too much data and become paralyzed! With these four simple guidelines, you can get started on the road to understanding your mutual fund investments more easily, while maintaining your forward long-term investing momentum.