How To Evaluate Your Fund

by Alan Lavine and Gail Liberman

How do you evaluate a common stock mutual fund’s risk? There are several ways to do it.

• Look at the fund’s year by year returns in up and down markets over at least a decade. If there are wide swings in the fund’s performance, it’s volatile. Compare the fund’s performance to similar funds. You want the fund that has the best return with the least amount of annual performance swings.

• Check the fund’s beta value or measure of volatility. The overall stock market has a beta value of 1. So a fund that has a beta value of 1.3 is 30 percent more volatile. If the S&P 500 goes up 10 percent, a fund with a beta value if 1.3 should go up 13 percent. On the downside, if the S&P 500 drops 10 percent, the fund with a beta value of 1.3 will drop about 13 percent.

• Check the fund’s “R Square” value. This is a measure of how closely a fund tracks the performance of the overall stock market. So a fund with an R Square of .90 closely tracks the performance of the S&P 500.

• Check the fund’s standard deviation of performance. In a nutshell, this is the range of a fund’s performance based on its average annual return. The higher the standard deviation, the more volatile a fund is considered.

Review these measures before you invest and compare these statistics to similar funds.

You can also evaluate to see if it gets the best possible return with the least amount of risk. Measures to consider include:

• Check the funds Sharpe Ratio. This is a return per unit of risk. The higher the Sharpe Ratio, the better the return per risk.

• Check the fund’s Treynor Ratio. This is also return per unit of risk measure. The higher the ratio, the better the return per risk.

• Check the Morningstar rating. Funds that get the best return per unit of risk carry a five-star rating. Funds that get one star from Morningstar were too risky in relation to their returns.

Be advised all of these measures are based on a fund’s past performance. The past is not always an indication of future results. All you can tell by these measures is how well the fund was managed.

Would you rather buy a fund that has a good record or a poor record? Consistency over the years is important.

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "Rags To Retirement," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show. Al and Gail’s new book is "Rags To Retirement:  Stories from people who retired well on much less than you think," published by Alpha Books.

More articles by Al and Gail can be found here.