The two main measures of evaluating the investment performance
of a mutual fund are yield and total return.
A mutual fund's yield
measures the dividend income that it pays to shareholders as a percentage of your investment. Yield is usually shown after deducting any fund expenses.
Money market funds
and bond funds
use yield to show current performance. For example, a bond fund that pays $1 in dividends from the interest earned on its bond holdings and has a net asset value
of $20 has a yield of 5%.
Yields on money market and bond funds are usually shown for seven- or 30-day periods. Yields for these short periods are annualized
so that you can compare their full-year returns to other funds with similar risk characteristics. Since money market funds invest in securities that are generally less risky than those bought by bond funds, money market yields are lower than bond fund yields by at least a few basis points
Yields are often stated as simple
and compounded yields
. Compounded yields assume investors will reinvest
dividend income. As a result, compounded yields are higher than simple yields.
Yields on money market and bond funds are directly related to market interest rates. As interest rates increase (as they did from June 2005 through August 2007) so do yields on money market and bond funds.
Both money market and bond funds come in taxable
varieties. Yields are lower for tax-exempt funds since these funds are exempt from federal income taxes. Tax-exempt funds may also be exempt from state income taxes for certain investors. To calculate the taxable-equivalent yield
of a tax-exempt fund, divide its yield by a factor equal to 1 minus your tax bracket. For example, if a tax-exempt money market fund yields 1.75% and you are in the 25% income tax bracket, your taxable-equivalent yield is 2.33%.
Yield is sometimes shown for stock funds but is not widely used to measure a stock fund's investment performance.
The second main measure of evaluating how well a mutual fund does is total return
. Total return includes dividends
and capital gains
that the fund distributes to shareholders. A mutual fund incurs capital gains when it sells some of its portfolio holdings to lock in profits or redeem
In other words, total return assumes that fund shareholders reinvest all their dividends and capital gains during the period for which the return is calculated. While this assumption may not mirror every investor's use of fund distributions, it allows for comparisons with other funds.
The Securities and Exchange Commission, which regulates the mutual fund industry, requires mutual funds to show rates of return for the following periods:
Year to date
If the fund has not been in existence for 10 years, it is required to show its rate of return since its inception date
For periods longer than one year, returns are stated as annual average returns. Returns for periods of less than one year are annualized.
The following table shows a set of investment returns for ABC and XYZ Funds, two fictitious mutual funds that each have assets under management of $100 million:
|1 Year (%)||3 Year (%)||5 Year (%)||10 Year (%)||Since|
(Jan. 1, 1990) (%)
When evaluating the past performance of a mutual fund, keep in mind that past returns are not a guarantee of future returns. You should also evaluate the long-term performance of the fund and not just look at its short-term performance.
You can see that while Fund ABC has done better than Fund XYZ for the year-to-date and one-year periods, Fund XYZ has consistently done better for longer investment periods.
Role of benchmarks
While a mutual fund wants to outperform other fund managers with similar investment objectives, its primary barometer of investment performance is how well it did relative to its benchmark index
. Fund managers often receive some of their compensation based on how well the fund does relative to its benchmark index.
For domestic stock funds, the S&P500 index
is widely used as a benchmark index. An index such as the Lehman Aggregate Bond Index is often used as a benchmark for taxable bond funds.
An actively managed
fund is expected to earn a rate of return at least as high as its benchmark index. If the fund earns a lower rate of return than its benchmark index for several periods, the fund may face a wave of shareholder redemptions as investors seek to invest elsewhere to earn returns at least as high as that of the benchmark index.
Instead of investing in an actively managed fund that may under-perform its benchmark index, some investors use an index fund
. Index funds mirror the composition of a benchmark index and charge lower fees than actively managed funds. As a result, index funds earn a rate of return that mirrors the benchmark index, minus amounts deducted for fees. Index fund fees are usually about half to one-third of the fees charged by actively managed funds.
Since actively managed funds charge higher fees and may also charge a load
, they have to outperform their benchmark index by an additional margin to justify their higher costs.
For example, consider a fund investor who earns 10% on an actively managed fund and pays 1.3% in annual fees for a net return of 8.7%. If an index fund earns 9.2% but only costs 0.3% (30 basis points) in annual fees, it has earned a higher return after fees.