How to Compare Mutual funds

How to Compare Mutual Funds

Risks, costs, and returns are three major factors that affect your mutual fund. When you compare mutual funds, these are the core factors you will be evaluating. Risk and return measurements can indicate how well (or how poorly) a fund will perform.

Before you start comparing funds, there are a few important things you should know:

When you compare mutual funds, always make sure the funds are the same category. There's no easy way to compare bond funds to stock funds.
Start by comparing 3-5 mutual funds in the same category. This will limit the amount of information you need to look through and speed up the search.
Your decision should be based on the fundamentals of each mutual fund.

I use a simple method to compare risks, costs, and returns for different mutual funds. This strategy is easy to learn and works for any type of fund. Once you learn this process, you will be able to keep your risk low, save money, and earn the best returns.

Let's start by looking at the numbers.

The 11 Most Important Mutual Fund Statistics

Numbers are the best way to compare mutual funds.

There are eleven important statistics that measure the performance of each mutual fund. These eleven numbers will save you time. Once you understand these statistics, you will be able to find the best mutual funds very quickly.

Trust me, these little guys will become your friends.

They will make investing easy for you.
They will do 90% of your research.
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They will show you how well your investment may perform.
Most importantly, they will lead you to the best mutual funds!

You don't need to be good with math. If you cringe whenever you hear the word statistics, don't worry. You just need to compare numbers. I'm going to show you exactly how to do it using these twelve performance statistics.

Evaluating Risk

Risk is the most important factor to consider when you invest. You should always evaluate risks before returns. Once you have a group of funds to compare, measure the risks for each fund.

Too many investors look only for funds with the highest returns. When they lose money, these investors are always surprised to learn that their risks were too high. Don't make this costly mistake. Here's what you should focus on first:

1. Standard deviation measures the amount of variation in a fund's returns, which is the most important indicator of risk. Since we are trying to minimize risk, make sure this number is as low as possible. Standard deviation should be at least lower than the category average.

2. A fund's Beta measures a its performance against the index. This is another critical risk measurement. A low beta measurement means less risk than the rest of the category. Focus on funds with a beta lower than 1, but the lower you can get this statistic, the better.

3. The Alpha measurement should only be used in conjunction with a fund's Beta. You want to look for funds (with a low beta) that have an alpha between 0 and 1. Alpha measurements are flexible, but any alpha that are too far outside this range may have either too much risk or poor returns.

Every mutual fund involves risks. However, you can minimize your losses and save money by eliminating high-risk funds first. Then we can eliminate funds with high investment costs.

Evaluating Costs

Learn this formula: average returns - investments fees and costs = below-average returns. The more in sales charges, fees, and expenses that you pay, the less you get to keep for yourself. You can save your money by comparing these four measurements:

4. Sales charges on a mutual fund should ideally be at zero. The larger the sales charge that you pay, the less money you are investing. Do not pay a sales charge, load, or initial fee if you can avoid it. If you must pay a sales charge to invest (for example, in your 401k plan), you may want to maximize other "no-load" mutual fund investments first. That should help decrease your costs.

5. The expense ratio measures the cost of a fund's management fees, which should always be low. Stock or bond funds should have an expense ratio less than 1, but lower is always better when it comes to costs. Expenses for any index fund should always be under .5%.

6. Turnover is a natural part of investing. Turnover measures how much a fund will change its portfolio throughout the year. A lower turnover will generally indicate a buy-and-hold strategy and low trading costs. This statistic can vary quite a bit depending on the type of fund you invest in: bond funds will have a higher turnover than stock funds. Index funds do not actively trade, so they should have an extremely low turnover.

7. Distributions are an important consideration for taxes. Find out when your fund pays out earnings. Bond funds usually pay regular earnings that are taxed each year. When you sell a stock fund, you are taxed on income and any gains or losses. Your earnings are usually tax-deferred or tax-free if you are investing in an IRA or Roth IRA.

You should be left with only low-cost, low-risk funds on your list. Now we need to find out which of those funds offers the best returns.

Evaluating Returns

Returns are easy to compare, which is why I evaluate them last. You are looking for funds that outperform their peers. The higher the returns, the better that mutual fund has performed in the past. Here's what to compare:

8. Total returns over the past 1,3,5, and 10 years are the most accurate measurement to use. You should evaluate returns at Net Asset Value. Do not use after-tax returns, because they may not accurately reflect the taxes you will pay. You want to always look at total returns and evaluate taxes seperately.

9. Fund returns +/- the fund category measure how much better or worse a fund has performed compared to similar funds. Standout funds are easy to spot in a category. You should have already eliminated the riskiest funds by now, so these category returns should show you which low-risk funds have performed the best. Look for the funds that consistently outperform the rest of the category.

10. Fund returns +/- the benchmark index are also helpful. The benchmark index measures the average returns for a sector of the market, so we are looking for higher returns than the market average. Returns that are consistently higher are a good sign, even if it's only by a small margin. Many funds can perform well over a short period of time. You are looking for funds that have above-average returns on a regular basis.

11. The last statistic is portfolio manager experience. These are the people who are going to be managing your money. Take note of how long the portfolio manager has managed that fund, and how much overall experience they have. You also want to consider the mutual fund company they work for. Portfolio managers usually have a short bio with their experience listed on the fund's website.

These are the same numbers that professional investors look at when they compare mutual funds.

Make Your Decision

You should always evaluate risk, costs and returns when you compare mutual funds. Once you have compared different mutual funds and have selected one of two of the best mutual funds, it's time to go back and review them in detail. Make sure you the funds you have chosen fit into your investment strategy. If you have extra time, you can look at extras like Sharpe Ratios and how much leverage your fund uses.

Your decision should be based primarily on a particular fund's investment strategy. If a fund's strategy doesn't sound like your investment style, take it off your list. Try not to get caught up in the flashy marketing or even the long history of a fund company. Things change in the financial industry constantly. Even mutual funds and fund companies can change over time.

Always read the prospectus for your top choices. Also consider reading the annual report and investor's guide for your selected funds. Reviewing each fund's documentation will help you learn as much as possible about a fund's strategy and performance. Surprisingly, most investors don't evaluate the companies that are actually managing their money. This does have an impact on your investment, so it's important to consider.

Finally, be decisive. Once you compare mutual funds, the best one should be obvious to you. Each fund will make sense, but one of them should stand out for one reason or another. It's that simple.

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