light blue timberland boots How To Dissect Mutual Fund Returns

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While the financial daily return information is useful, there is more to mutual fund returns.

Savvy investors will seek answers to such questions when evaluating mutual fund returns. Before getting into the nitty gritty of mutual fund returns, it is good to understand what the data reported in the financial daily really mean.

Total Return

Fidelity Contra reported 16.23 1 year return is the fund total return for the December 31, 2004 to December 31, 2005 period. In practical terms, $10,000 invested in the fund on December 31, 2004 is worth $11,623 on December 31, 2005. The total return includes more than the increase (or decrease) in the fund share price. It also assumes reinvestment of all dividends as well as short and long term capital gain distributions into the fund at the price at which each distribution is made.

Compound Annual Return

The reported 6.21 5 year return is the fund compound annual return (also called the average annual return). The compound annual return is a calculated number that describes the rate at which the investment has grown assuming uniform year over year growth during the 5 year period.

A $10,000 investment in the Contrafund on December 31, 2000 has grown to $13,515.34 on December 31, 2005. The ending value of $13,515.34 = $10,
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000[(1 + 0.0621)^5] where 6.21 is the compound annual return. The investment in the fund grew at an implied annual growth rate of 6.21 over the 5 year period.

While total return and compound annual return are useful, they do not tell how a particular mutual fund has performed compared to its peers. They also do not provide information on the return actually earned by investors after accounting for taxes. It is the difference between the total return of the fund and the total return of an appropriate benchmark over the same period. It is therefore appropriate to compare its performance with that of an average large cap growth fund.

While Fidelity Contra has a compound annual return of 6.21 for the 5 year period ending December 31, 2005, Morningstar reports the average large cap growth fund has an average annual loss of 8.48 over the same period. The S 500 index has an average annual return of 0.54 over the same period. For such non qualified accounts, after tax return is the return realized after accounting for taxes.

Short term capital gains and short term capital gain distributions from a mutual fund are currently taxed at the same rate as earned income. Dividends, long term capital gain distributions and long term capital gains realized from the sale of fund shares are currently taxed at a lower rate.

Fidelity states the compound annual return for Fidelity Contra before taxes is 6.21 for the 5 year period ending on December 31, 2005. It is important to assess a fund return in light of the amount of risk the fund manager takes to deliver that return.

is commonly measured using the Sharpe Ratio. The ratio is calculated using the formula (mutual fund return risk free return)/standard deviation of mutual fund return. The higher the Sharpe ratio, the better is the fund return per unit risk.

Based on returns for the 3 year period ending on November 30, 2005, Morningstar reports Fidelity Contra Sharpe ratio as 1.74. The fund Sharpe Ratio may be compared with those of similar funds to determine how the fund risk adjusted return compares with those of its peers.

Beyond Mutual Funds

Return concepts such as relative return, after tax return, and risk adjusted return may also be used for evaluating separately managed accounts, hedge funds and investment newsletter model portfolios.

The AlphaProfit Sector Investors Newsletter, for example, tracks the total return and compounded annual return of its Core and Focus model portfolios. To provide Subscribers with a more complete picture of model portfolio returns,
light blue timberland boots How To Dissect Mutual Fund Returns
this newsletter also tracks the relative and risk adjusted returns of the model portfolios. Metrics such as relative return and after tax return offer insights on the fund relative performance and tax efficiency. Risk adjusted returns enable investors to assess how a fund returns stack up when risk is factored in.