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As an investor, it’s important to carefully monitor the performance of your mutual funds to make sure your income is working for you. Measuring the performance of mutual funds is crucial to making informed decisions and maximising returns.
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How to evaluate mutual fund performance?
1. Identify the benchmark
A benchmark serves as a reference point to gauge the performance of a mutual fund. It represents a market index closely resembling the fund’s investment strategy. For example, suppose your mutual fund predominantly invests in large-cap Indian stocks. The Nifty 50 or BSE Sensex can serve as potential benchmarks in that case.
Compare the fund’s returns with its benchmark over various periods, like one year, three years, and five years. If the fund consistently outperforms its benchmark, it indicates a positive track record.
2. Expense ratio
The expense ratio is the annual fee the mutual fund company charges for managing your investment. It is expressed as a percentage of your invested capital. While evaluating mutual fund performance, keep a close eye on the expense ratio, as it can significantly impact your overall returns.
Lower expense ratios are preferable, as they leave more money in your investment to grow. High expense ratios can eat into your returns and erode the fund’s performance. Ensure the fund’s expenses are reasonable and in line with industry standards.
3. Check the historical performance data
Past performance does not guarantee future returns, but analysing a mutual fund’s historical performance can provide valuable insights. Look for consistent performance over multiple market cycles rather than relying solely on recent performance.
A fund that has demonstrated steady growth and weathered various market conditions is likely more reliable. However, remember that a stellar past performance may not continue indefinitely, so a holistic approach to evaluation is essential.
4. Risk-adjusted returns
High returns appeal but might come with higher risks. Evaluating risk-adjusted returns helps you assess how much risk a mutual fund has taken to achieve its performance. A fund with high returns and low volatility is generally more attractive to investors.
One common measure of risk-adjusted returns is the Sharpe ratio. This ratio considers the fund’s returns and the level of risk it took to generate those returns. A Sharpe ratio that is higher suggests superior risk-adjusted performance.
To wrap up
Evaluating mutual fund performance is vital for making informed investment decisions. Embarking on an investment journey with mutual funds can be immensely fulfilling. You can maximise your potential for wealth creation and financial security with diligent evaluation.