As even the most wet-behind-the-ears investor will tell you, a mutual fund’s historic performance is no guarantee of future performance. Nonetheless, a fund’s earnings reports are among the most useful tools available to guide investment decisions. The diverse nature of a mutual fund’s holdings, its manager’s tactics, the performance of individual stocks and earnings distributions all combine to make understanding a fund’s performance much more complicated than analysis of a single stock’s performance. While earnings reports contain many types of information, bringing that information into focus can be a challenge.
1. Focus on long-range performance rather than short-term yields. Many factors, such as market fluctuations and unprecedented performance in a large sector in which the fund invests, can have a significant impact on a fund’s short-term earnings. Long-term yields — those over two years or longer — are the best measures of performance, as virtually any fund can experience gains or losses in the short term.
2. Match the type of fund to its earnings potential. A growth fund operates by selling stocks for a profit, making money on gains on each sale. In contrast, a dividend fund purchases stocks for their potential dividends rather than those that will increase in value. The fund type may impact how managers invest in the future and how the fund will ride out different market conditions.
3. Examine the size of the fund’s holdings and its age. New funds with relatively small holdings often aren’t as diversified as older, more developed funds. Because of this, a couple of unusually high-performing stocks can greatly affect a small fund’s performance in ways that may not reflect management decisions accurately.
4. Weigh a fund’s volatility against past performance. Volatility ratings measure how risky it is to invest in a fund. While funds with a historically high annual return may be inviting to investors, those with high volatility may be likely to decline drastically in value. Likewise, volatility may also indicate a fund that routinely outperforms the market, even if those investments come at a higher risk.
5. Identify the fund’s turnover rate. Funds that trade higher volumes of stock may feature a more hands-on approach to managing assets, but they are likely to incur lots of transaction fees in the process. While high turnover may reduce earnings when the fund performs well, the additional fees can compound losses if its holdings tank.
6. Identify the fees and other costs the fund assesses against its members. While fees and other charges aren’t indicative of a fund’s performance, they can quickly eat into your realized earnings if fund membership is expensive.
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