Whats the most prominent thing you notice about mutual fund advertisements? In most cases, its the funds return. Quite often, these returns are truly eye-popping. But if you look closer at the ads, youll see that many of the highest returns are for short periods of time, such as one year or three years. And a mutual funds short-term return is not, by itself, reason enough to buy that fund so dont rush to your checkbook.
Actually, a mutual funds short-term performance may tell you less about the fund than about whats been happening in the financial markets. If most stocks rise significantly for a few years, the chances are pretty good that a stock-based mutual fund is going to do well, too.
But more importantly, you shouldnt evaluate a fund on its short-term return because a mutual fund is a long-term investment. To assess a funds long-term performance, youll need to look at its annualized return its return over a period of time other than one year. For example, a two-year return of 10 percent could be stated as an annualized rate of return of five percent. And by comparing annualized returns, you can learn a lot about a funds historical performance. If a funds annualized return for the last three years is 12 percent, but over 10 years it was just five percent, you could conclude that the results of the past three years are not representative of the funds long-term track record.
Apart from its annualized return, what else should you look for when considering a mutual fund? Here are a few suggestions:
*Performance against similar funds How has the fund youre considering performed in comparison to other funds with the same investment objective over 10- and 15-year time periods? That is, if youre evaluating a growth-and-income fund, contrast its performance against the universe of other growth-and-income funds.
*Fund managers longevity Ask your financial advisor how long a fund manager or a management team has been responsible for making the investment decisions. Assuming the fund has a superior 10- and 15-year track record to begin with, the longer a manager has been in place, the better.
*Expense level Different mutual funds have different costs associated with them. All factors being equal, look for those funds with the lower expense levels. The more you pay each year in expenses and fees, the lower your overall return. However, some funds have justifiably higher expenses, and you may want to consider these funds to help diversify your mutual fund holdings.
*Investment overlap Even if a fund has shown consistently good returns and has a talented, experienced manager, it still might not be right for you, particularly if it overlaps with similar funds in your portfolio. You might be better off by purchasing a different kind of mutual fund and thereby broadening your holdings. Your financial advisor can help you create a diversified mutual fund portfolio that fits your risk tolerance and investment objectives.
Finally, ask your financial advisor for a copy of the funds prospectus, which contains complete information about the fund, including risks, charges and expenses as well as other important information that should be carefully considered.
By doing some research and learning all you can about a mutual fund, youll be prepared to make smart investment decisions.
