Investing in mutual funds has an inherent risk assumed upon the ownership. However, the performance of mutual funds can be quantified with the mathematical calculation of the historical returns. The correlation between the potential risk and the potential returns constantly puts forth the opportunities to invest in mutual funds and drive maximum potential returns with minimum underlying risk. The past performance of a mutual fund may not predict the exact future of the fund, but it can certainly guide one to the right set of stocks in the market. Understanding what to avoid and what to approach can steer one in the right direction in the market.
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Method to Judge a Fund’s Performance
Evaluating and comparing the performance of two or more mutual funds can help one make informed decisions about their investment choices. Mutual funds offer the chance to invest in a diversified portfolio, increasing the likelihood of returns. Assessing a fund’s performance can determine if it aligns with investment goals and risk tolerance. Discovering that a large-cap fund one thought was stable is performing poorly can be disappointing. However, it doesn’t necessarily mean one should immediately exit the fund. Several methods can help gauge a fund’s performance beyond just historical data, allowing investors to decide whether to continue investing.
Judge a Fund’s Performance Relative to Its Benchmark, Not Its Returns Alone
An equity mutual fund’s performance may appear poor during a market downturn due to its investment in stocks. However, evaluating the fund solely based on its returns in a falling market can be misleading. Instead, focus on the fund’s ability to outperform its benchmark. Comparing the fund’s returns to its benchmark helps gauge its performance accurately. For instance, if a large-cap fund yields 30% returns compared to its benchmark’s 25%, it signifies strong performance.
Avoid Comparing Funds Across Different Categories
Comparing the returns of funds across different categories, such as large-cap, mid-cap, or small-cap, is not a fair assessment. Instead, compare a fund with others in the same category. Each category exhibits distinct performance patterns. Evaluating a large-cap fund’s returns during a downturn against a mid-cap fund’s returns during an upswing can lead to inaccurate conclusions. Compare the fund’s returns to its category average to gain a more meaningful insight.
Employ Consistency Measures to Assess Fund Performance
Consistent outperformance of a mutual fund relative to its benchmark and category average over a prolonged period indicates a successful investment strategy. Even if the fund experiences short term underperformance, a history of consistent outperformance suggests that the fund’s strategy is effective. Review the fund’s performance over multiple one-year periods to assess its consistency. Additionally, consider risk-adjusted returns to evaluate the fund’s performance relative to its risk exposure.
Track Record and Competence of the Fund Manager
The fund manager plays a crucial role in making investment decisions and selecting stocks for the portfolio. Assess the fund manager’s competence based on their track record and expertise in fund management. Past performance can serve as a valuable indicator of the manager’s capabilities. Monitoring the fund manager’s track record provides insights into their investment approach and aids in making informed investment decisions.
Conclusion
When evaluating mutual fund performance, it’s essential to compare the fund’s returns against its benchmark to assess its ability to outperform the market. Avoiding comparisons across different fund categories is also crucial, as each category has unique performance characteristics. Additionally, analysing the fund’s consistency in outperforming its benchmark over time provides valuable insights into its investment strategy. Considering the track record and competence of the fund manager is equally important, as their expertise influences investment decisions. By employing these evaluation methods collectively, investors can make informed decisions about their mutual fund investments and better understand the fund’s performance relative to its peers and market benchmarks.
