Investment professionals mainly compare mutual fund returns to a “benchmark” — a broad market comparison that attempts to mirror that mutual fund’s basket of investments. There are literally thousands of benchmarks, but the most well-known is the S&P 500, which is made up of the 500 largest company stocks. The Russell 2000 is another, which is comprised of the 2,000 smallest publicly-traded stocks within the Russell 3000, which is comprised of the 3,000 largest stocks.
Here is an example of how Schwab compares the Janus Henderson Balanced Fund Class T, a mutual fund with the symbol JABAX. In addition to the S&P 500, JABAX is compared to a Morningstar category, “Allocation–50% to 70% Equity,” a benchmark Charles Schwab believes is the closest comparison to JABAX.
Analyzing mutual fund investment performance for yourself
When it comes to analyzing mutual fund investment performances, don’t believe the pundits. Instead, here are four tips to judge performance for yourself.
1. Use the three main benchmarks as a starting point: Three main investment types are stocks, investment-grade bonds, and cash/money market. Here is each type’s main benchmark:
- Stocks = The S&P 500 Index
- Investment-grade bonds = The Bloomberg Barclay’s Aggregate Bond Index (aka, the “Agg”)
- Cash/money market = The one-year Treasury yield
Recently, I was opening a money market account. First, I checked today’s one-year Treasury rate, which on February 14 was 1.49%. I asked my banker for a money market rate, and he quoted 0.15%. I pushed back, and he offered 0.85%. A large investment company quoted me 1.28%. While its yield is lower than the one-year Treasury, I learned its average U.S. Treasury Bond holding is 38 days, not one year, so the slightly lower rate does make sense. As you can see, the one-year Treasury was a good starting point.
2. Know that there are no perfect benchmark. No two mutual funds have the exact same investments, and for that reason, trying to analyze performance can be difficult and confusing. How can you compare apples to apples? You cannot. For example, the mutual fund above, JABAX, is compared to “Allocation—50% to 70% Equity,” and it beat its returns handsomely. You should not assume that particular benchmark is the perfect way to compare this mutual fund to anything else. For example, perhaps JABAX’s basket of investments takes greater risk than the given benchmark.
3. Mutual fund performance results are easily manipulatable. Mark Twain once said, “Facts are stubborn things, but statistics are pliable.” And as Benjamin Disraeli said, “There are three types of lies — lies, damn lies, and statistics.” Mutual fund performance reports work like statistics; they’re easily tweaked to the advantage of whoever is presenting them. For example, your mutual fund beat the S&P 500 over three years, but it performed well below the S&P 500 over five years. Which timeframe would you show if you were trying to market that fund? The key is to be aware that just because a few comparisons show success doesn’t necessarily mean your mutual fund is successful overall.
4. Compare returns for yourself. Financial advisors and mutual fund managers normally provide investors with mutual fund performance by choosing their own benchmarks and time periods. A smart way to check the fund’s performance is by comparing it to a few other appropriate benchmarks over a few different time periods. For example, with JABAX, perhaps you could choose two and four years as an alternative timeframe, and then look for other benchmarks to which JABAX also could be compared.
Mutual fund returns may not be what they seem
Mutual fund performance deceives the average investor. The tendency is to view performance comparisons as the truth, but it’s not the truth. It’s just an estimate. There is no way to compare apples to apples. When you do analyze mutual fund returns, try to do so with a cynical eye.
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