Broker Check

Getting Mutual Fund Numbers to “Speak Your Language”

| January 04, 2018
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Most mutual fund investors are familiar with the different types of funds available, and how investing in a variety of funds can help create diversity in a portfolio. The funds themselves, along with independent rating services, publish a variety of performance data to help you make informed decisions. However, performance can look very different, depending on what is being measured and the benchmark used for comparison. 

Benchmark Comparisons 

There are three types of benchmark comparisons, each of which produces a different level of meaning: market comparisons, peer group comparisons, and risk-adjusted comparisons. Performance is also measured for different time periods. If you understand the measuring sticks used, you will have a better grasp of what is being measured. 

Perhaps the most common market benchmark for mutual fund performance is the Standard and Poor’s 500 (the S&P 500). The S&P 500 is composed of many large companies that form the backbone of American industry. In contrast, the more familiar Dow Jones is a more limited measure of 30 large industrial stocks. Taken collectively, the performance of the S&P is a broad indicator of stock market performance. Consequently, as a first level of comparison, it is useful to know if a particular mutual fund over- or under-performed versus the S&P 500 for a given time period. This comparison answers the question: Did my fund “beat the market” over a particular period of time? 

However, a comparison with only the S&P 500, as a proxy for the market, may be limiting. For example, if your particular fund holds stocks of smaller companies, or invests overseas, how meaningful is a comparison with the benchmark for larger American companies? 

Consequently, for market comparisons, it is important to use the appropriate market benchmark. For instance, the Russell 2000 Index is widely considered to be the benchmark for funds comprised of small company stocks, while the EAFE (Europe-Australia-Far East) Index may prove more useful for comparison with funds composed primarily of foreign stocks. 

From Benchmarks to Peer Groups 

Even comparisons with the appropriate benchmark, while interesting, do not tell the entire story. If a fund you owned outperformed its market benchmark by five percentage points, you might be tempted to feel pretty good about its performance. However, would you still feel the same if you later found out that every fund in the same category outperformed the benchmark, and your fund (even though it “beat the market”) was ranked last in its category? 

Consequently, peer group measures provide an “apples-to-apples” comparison. One common peer group measure is to simply rank, by performance, all the funds within a specific group. Another peer group measure compares the performance of one particular fund with the average performance of all the funds in that category. Thus, a peer group comparison is more specific, while the market comparison is more general. 

Accounting for Risk 

The various mutual fund reporting services (e.g., Morningstar Mutual Funds) will do the complex math and convert risk-adjusted performance into a simplified form (usually some type of ranking system)—which must follow strict guidelines. The most common time frames for stating performance figures are one, three, five, and ten years, or the life of the fund if shorter. This is the standardized performance required by the Securities & Exchange Commission (SEC). However, investors should also look at the prospectus or material provided by the fund company. 

Mutual fund performance data can be a little overwhelming, and you should always remember that past performance does not guarantee future results. However, if you know what is being measured, and the benchmark used for comparison, you can make the numbers “speak your language.” 

Mutual funds are sold by prospectus, which includes additional information on risks, charges, and expenses. Investors should read the prospectus carefully before investing. An investment in the fund is only one part of a balanced investment plan.

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