| Comparing mutual funds is fairly simple when you | | | | multiplying by the standard deviation of a relevant |
| have a good understanding of the key statistics | | | | index. For example, if you are comparing |
| and know how to employ them effectively. The | | | | emerging markets stock mutual funds, an |
| key statistics listed below should serve you well in | | | | appropriate index would be an emerging markets |
| comparing mutual funds. | | | | stock index. Using a relevant index rather than |
| Mutual Fund Returns | | | | the S&P 500 isn't absolutely necessary but it has |
| *Average Return | | | | the advantage of providing you with the |
| *Risk-Adjusted Return | | | | opportunity of comparing the individual funds with |
| Mutual Fund Risk | | | | the index. If none of the funds you are comparing |
| *Standard Deviation | | | | can beat the index on a risk-adjusted basis, then |
| *Beta | | | | you should look at some other funds or buy the |
| Risk-to-Return | | | | index. |
| *Sharpe Ratio | | | | The final quantitative step in comparing mutual |
| *Coefficient of Variation | | | | funds is the use of some measure of |
| *Treynor Ratio | | | | risk-to-return. Here the Sharpe ratio is the |
| You'll find these statistics readily available on the | | | | hands-down winner for use in comparing mutual |
| Internet at sites like Yahoo! Finance. These key | | | | funds, as it is computed using total risk. The |
| statistics should be used in the order in which | | | | coefficient of variation is a quick and dirty |
| they are listed. | | | | substitute for the Sharpe ratio. The Treynor ratio |
| Risk and return should not be used independently | | | | considers the degree of diversification in its |
| to compare mutual funds. Indeed, you need to | | | | computation and is best used for evaluating the |
| use one of the measures of risk-to-return to | | | | competence of funds' managers. |
| compare mutual funds on a relative basis. | | | | The Sharpe ratio is the excess return (the actual |
| Published annual returns are usually computed by | | | | return less the risk-free rate) divided by the |
| compounding monthly returns and multi-year | | | | standard deviation. The result is the real return |
| averages are usually computed as the geometric | | | | per unit of risk. When comparing similar mutual |
| mean of the annual returns, which yields a | | | | funds, preference should always be given the one |
| compound return and is the metric that will tell | | | | with the highest Sharpe ratio. Choosing one with a |
| you how well you would have done if you had | | | | slightly lower Sharpe ratio might be appropriate if |
| been invested in a fund over the period of | | | | it displayed a lower degree of correlation with the |
| interest. However, the arithmetic mean, i.e., a | | | | other securities in your portfolio. |
| simple average of the annual means, is the | | | | By themselves, the yield and expense ratio won't |
| appropriate metric for evaluating a mutual fund's | | | | tell you a lot, but they should be factored into |
| ability to deliver good returns. The returns | | | | returns and you should verify that they have |
| delivered over various periods of time will give | | | | been. Yield is a consideration if one of your |
| you a good feel for a fund's ability to consistently | | | | objectives is to produce a stream of income. |
| deliver good returns. More weight should be given | | | | Also, in taxable accounts, yield creates a tax |
| to the longer periods. | | | | liability. |
| The returns published by independent sources | | | | Turnover will affect return to the extent that |
| should be total returns (they include dividend and | | | | trading costs eat into returns, but it will always be |
| capital gains distributions) net of fees and | | | | reflected in the returns. In tax-deferred accounts, |
| expenses. Be sure to verify this. | | | | turnover that pays its way is not an issue. |
| In investing, risk is measured in terms of volatility. | | | | Turnover is an issue in taxable accounts, as it |
| Total risk is measured by the standard deviation | | | | generates capital gains tax liabilities. |
| of returns and it is the standard deviation that | | | | Finally, manager tenure should always be a |
| should be used to compare mutual funds. Beta is | | | | consideration when evaluating and comparing |
| a measure of residual risk, i.e., the risk inherent in | | | | mutual funds other than index funds. A mutual |
| the overall market. Beta is an indicator of the | | | | fund with a good long-term record under the |
| volatility of a security relative to a broad market | | | | same manager is highly desirable, and there should |
| index such as the S&P 500. | | | | be a co-manager or fully indoctrinated |
| Although we have a natural aversion to risk, risk | | | | protégé to carry on in the manager's |
| is what justifies earning a return in excess of that | | | | absence. |
| of riskless securities like T-bills, but expected | | | | Always compare apples to apples. Your |
| returns must be commensurate with the level of | | | | comparisons will be most valid if you compare |
| risk. If two mutual funds have equivalent returns | | | | mutual funds that are in the same asset |
| but one has a significantly higher standard | | | | category, similar in size and managed by the |
| deviation, the one with the higher standard | | | | same style. For instance, don't compare a huge |
| deviation should be rejected in favor of the other. | | | | large-cap growth fund with a tiny small-cap value |
| If, on the other hand, two mutual funds have | | | | fund. |
| equivalent risk-adjusted returns, you may prefer | | | | If you use these key statistics effectively to |
| the riskier of the two if you have a high risk | | | | compare mutual funds, you should be very |
| tolerance, as it has the potential to deliver higher | | | | satisfied with most of your selections. But nothing |
| returns. | | | | is certain in investing, so be prepared for an |
| The risk-adjusted return is calculated by dividing a | | | | occasional disappointment. |
| fund's return by its standard deviation then | | | | |