It’s nice to see a gain on your investment when you receive your quarterly statement, but that doesn’t paint the whole picture of how the investment has performed, its outlook or if it’s the appropriate investment. So we thought we would share a few ways to evaluate a mutual fund or ETF’s performance.
- Returns: This is the most commonly used metric to evaluate how well a fund is doing. If you saw a 20% return for 1 year then it is likely characterized as a good fund, but the more telling way would be to compare returns to an appropriate benchmark and look at the returns over several time frames. By just looking at that one data point you are only getting a small sliver of the story. What if that fund had underperformed over the past several years or underperformed its benchmark? Then maybe it’s not as good an investment as initially thought.
- Standard Deviation: This is the measure of dispersion of returns around the mean. It helps to frame how much volatility you should expect. For example, a stock with an expected return of 5% and a volatility of 5%, would imply a range of returns from -5% to 15% assuming a normal distribution and that 95% of outcomes lie within two standard deviations. While a stock with an expected return of 5% but the volatility doubled to 10% would expect to see returns range from -15% to 25%.
- Risk Adjusted Return: The Sharpe ratio, which is the return of the fund minus risk-free rate (use 3-month T-Bill) divided by the standard deviation, essentially lays out how much return you are getting per unit of risk. The higher the Sharpe ratio the more attractive the risk adjusted return is and vice versa.
These are just a few ways that you can evaluate your portfolio investments in order to make sure that they conform to your plan. And remember, past performance is not indicative of future results.
