TAKING STOCK: Mutual fund analysis

Dear Mr. Berko: 

I’m a 46-year-old engineer, and my wife is a 55-year-old parole officer. 

We have good jobs and earn an adequate living. 

We inherited $160,000 from an uncle and want to invest in a portfolio of mutual funds for our retirement. 

We visited three stockbrokers and have a list of 27 funds. One broker recommended investing $10,000 each in 16 funds. 

How do we choose the best mutual funds for us?

BD, Punta Gorda, Fla.

Dear BD: 

There are over 7,000 mutual funds and over 400,000 stockbrokers eager to help you. 

Because you’re an engineer, the following metrics are up your avenue. 

Meanwhile, several brokerages have smartphone apps to compute the following performance criteria, which are important in fund selection.

Alpha is a measure of a fund’s performance on a risk-adjusted basis.

 It takes the volatility of a fund and compares it with the performance of a benchmark index, such as the Standard & Poor’s 500, the S&P/BGCantor U.S. Treasury Bond Index, the Dow
Jones Global Total Stock Market Index and the various MSCI indexes. 

The excess return of the fund over the index is called its alpha. Alpha represents the value that a portfolio manager’s skills bring to the fund. 

An alpha value of 1 means the fund has outperformed its benchmark by 1 percent. An alpha of negative 1 indicates an underperformance of 1 percent.

Beta is a measure of the volatility of a fund in comparison with the broad market. 

A beta of 1 suggests that a fund will move in lockstep with the stock market. A beta of 1.2 indicates that the fund is 20 percent more volatile than the market. 

A beta of less than 1 indicates that the fund will be less volatile than the market.

R-squared is a measure representing the percentage of a fund’s portfolio that can be explained by a movement in a benchmark index. 

For a fixed-income security, the benchmark might be the S&P/BGCantor U.S. Treasury Bond Index, and with equity funds, the benchmark might be the S&P 500. 

R-squared values range between zero and 100. A fund with an R-squared value between 85 and 100 has a performance record that’s closely correlated to the index. A fund with a rating
of 70 or lower would not perform like the index and should be avoided.

The total risk of a fund (market risk, security-specific rick and portfolio risk) is measured by standard deviation. 

This tells an investor how much the return of the fund deviates from the expected returns based on historical performance. 

The standard deviation determines this risk by measuring the degree to which the fund fluctuates in relation to the average return of the fund over a specific time period. So standard deviation measures the consistency of the fund’s returns. 

A fund with a high SD has a more volatile and riskier net asset value than a fund with a low SD. Please note that for the SD to be effective, investors must use it to compare peer group mutual funds. For example, a large-cap fund must be compared with a large-cap fund with the same investment objectives.

The Sharpe ratio measures the return the fund generates relative to the risks it takes. 

The Sharpe ratio is calculated by subtracting the risk-free rate of return (U.S. Treasury bonds) from the return of an investment and dividing the result by the investment’s standard

This ratio tells us whether an investment’s returns are because of smart investment decisions or they are the result of excessive risks. 

The higher the Sharpe ratio the better the fund’s return relative to the amount of risk taken. A negative SR indicates that the risk-free asset will perform better than the fund being analyzed.

Some fund families have websites that calculate these indicators, and this information is available on various financial websites and is usually incorporated in research reports. 

Purchase only no-load funds, and stay with one fund family, such as Fidelity, T. Rowe Price or Vanguard. 

Each family offers good diversification, so you only need five or six funds. Your investing in 16 funds would mean a fantastic payday for that brokster.
Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at mjberko@yahoo.com. To find out more about Malcolm Berko and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.

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