{"id":6558,"date":"2013-01-04T12:28:50","date_gmt":"2013-01-04T18:28:50","guid":{"rendered":"http:\/\/www.coolchecks.net\/blog\/?p=6558"},"modified":"2014-09-08T12:32:10","modified_gmt":"2014-09-08T18:32:10","slug":"measure-performance","status":"publish","type":"post","link":"https:\/\/www.coolchecks.net\/blog\/investing-basics\/mutual-funds\/measure-performance.html","title":{"rendered":"Measuring the Relative Performance of a Mutual Fund"},"content":{"rendered":"
\"Investing<\/a>
Investing In Mutual Funds<\/figcaption><\/figure>\n

Do you know how to measure your mutual fund performance? Are your personal finances<\/a> allowing you to start using your savings as another way to earn money?<\/p>\n

To most, assessing the true performance seems like a complicated task. \u00a0Many advertisements tout certain funds as having 5-star ratings or as being the \u201cbest choice\u201d for American investors. \u00a0But how exactly are these performance ratings determined? \u00a0Can these ratings be trusted? \u00a0What exactly do we mean when we say a mutual fund generated a return of 20% and does this give us the true picture of a fund\u2019s performance?<\/p>\n

It can be very easy to get caught up in the hype of the media advertisements attached to many mutual funds, so making the best choice in a mutual fund investment requires a solid understanding of how performance should be measured. \u00a0Here, we will look at how to measure the relative performances of mutual funds so that we can properly assess the claims made in their advertisements.<\/p>\n

Using the Morningstar Style Box
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The first step in accurately assessing a fund\u2019s past performance is to look at the Morningstar Style box, which divides mutual funds by market capitalization (small, medium and large) and by its investment objective (value, growth, and blend). \u00a0The box has 9 sections and can be seen in the graphic below:<\/p>\n

\"\"This configuration allows you to place your chosen fund its correct category (one box on the \u201ctic tac toe\u201d spectrum). \u00a0This is helpful because it will allow you to compare total performance (rates of return) with funds of a similar size and investment approach. \u00a0Typically, investors make these comparisons over 3, 5, and 10 year time horizons (allowing you to smooth out short term fluctuations in the market). \u00a0Of course, performance comparisons can also be made relative to a benchmark index like the S&P 500, but the more specific performance comparisons (to those funds in a similar Morningstar category) tend to be more useful.<\/p>\n

Separating Your Fund from the Market as a Whole
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When looking to make an assessment of the market as a whole, the S&P 500 can be a useful benchmark for determining broad economic performance. \u00a0But in order to have a meaningful idea of your fund\u2019s true merits, it must be compared to its peers those within the same style box category.<\/p>\n

For example, roughly 90% of the available mutual funds underperformed the S&P 500 in 1998. \u00a0Index funds tied to the S&P 500 fall into the \u201cblend\u201d and \u201clarge cap\u201d fund categories (which suggests that the S&P 500 has limited exposure to value and growth stocks). \u00a0In this year, as most mutual funds offered weaker returns than investments in the S&P 500, a majority of the similarly categorized \u201clarge cap\u201d and \u201cgrowth\u201d funds actually beat the S&P 500 index. \u00a0From this, should we surmise that the managers of these funds put forward an exceptional performance? \u00a0Not exactly.<\/p>\n

In 1998, growth funds with large market caps generated average returns of about 35% (which was about 8% better than what was seen in the S&P 500). \u00a0But some funds (such as the Vanguard Growth Index fund) generated returns above 42% for the year. \u00a0So, when some funds advertise the performance as \u201cmarket leading\u201d because they beat the S&P 500 benchmark, the first question to ask is whether or not the fund falls into the \u201clarge cap\u201d and \u201cgrowth\u201d categories. \u00a0If this is true, you should not be as impressed by these results as you would be if the fund fell into one other categories (which would be a more impressive feat). \u00a0This is because the assets in that fund should have had no problem beating the S&P that year.<\/p>\n

Matching Comparable Funds
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There are some names that are well known in the fund community (such as Vanguard) that aim to provide access to index funds which fall into many of the Morningstar style boxes (Vanguard funds fall into 7 of these 9 categories). \u00a0So, when looking for funds to use as a measured standard of performance, these funds provide a good starting point.<\/p>\n

Morningstar.com allows you to search for your fund using its name or ticker symbol. \u00a0You will then see a wide selection of informational articles related to the fund. \u00a0This will include its style box categories, yearly performance relative to the S&P 500 (for assessment against the broader market), and performance comparisons to funds that are more directly related to your fund of choice. \u00a0\u00a0A quick internet search of this type can allow investors to assess the relative performance for mutual funds before making any share purchases.<\/p>\n

SmartMoney\u2019s Comparison Tools
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Other sites, like SmartMoney.com, will allow you to compare funds through time periods of 1, 3, or 5 years. \u00a0These types of sites allow you to monitor how the funds in your 401(k) plan are performing when compared with a similarly positioned index fund. \u00a0The Vanguard funds make these comparisons particularly convenient and the following list shows which funds are comparable for each style box category. \u00a0You can use the ticker search at SmartMoney.com to look for these match-ups:<\/p>\n