Mutual funds are designed for long-term investors. They seek steady, predictable growth and less volatility than the overall market. Mutual funds have historically performed below the market average in bull markets but outperformed the market during bear markets. Long-term investors tend to have lower risk tolerances and are more concerned about minimizing risks in mutual fund investments than they want to maximize gains.
Each investor's expectations and expected return will determine a mutual fund's "good" return. Investors will be happy with a return roughly equal to the market's average return. A return that exceeds or meets that goal would be considered a good annual return. Investors looking for higher returns on their investment would be disappointed.
Economic conditions and market performance are important factors determining the return on investment. A fund investor might be satisfied with a 3% return if stocks drop 10% to 15% during a bear market. Investors subject to different market conditions would not be satisfied with the same return.
To better understand the mutual fund's performance over time, investors need to understand the differences between annual returns (or annualized returns). An annual return is the percentage change in investment during 1 year. Annualized return, the percentage change in investment over a shorter or longer period than one year, can be expressed as a yearly rate.
A Good Average Annual Return for Mutual Funds
The average annual return of a mutual fund is dependent on two main factors: the type and historical timeframe. To have a realistic expectation of future performance, it is advisable to look at long-term returns such as the 10-year annualized rate when researching mutual funds. Stock mutual funds have a good long-term return of 8% to 10% (annualized for at least 10 years). A good long-term return for bond mutual funds would be between 4% and 5%.
The SPDR S&P 500 Index ETF SPY, for example, has an annualized return of 9.44% since its January 1993 inception. A stock mutual fund with long-term returns, such as the 10-year annualized rate, that beats this record is considered a "good fund" in terms of performance. The iShares Core Agregate Bond ETF has had an annualized return (4.29%) since its September 2003 inception. This record is a benchmark for a bond fund. A good fund would have a bond fund with at least 4.29% long-term performance.
Mutual Fund Returns vs. Individual Stocks
Although many investors prefer to invest in individual stocks over mutual funds, experts disagree with this financial decision. It becomes more difficult to determine an average return when looking at individual stocks. As with the various sectors, certain stocks will outperform others.
Mutual funds offer many of the same benefits as investing in individual stocks. Instead of purchasing a handful of stocks, you can buy hundreds or even thousands. Stocks that outperform the market are available to you. The downside is that the underperforming stocks aren't enough to cause any damage. Diversification is crucial.
Importantly, mutual funds provide more exposure to other assets than just stocks. If you create your portfolio using individual stocks, your portfolio will only have equity exposure. As a result, your portfolio will likely take a significant hit when the stock markets are down. A portfolio with a greater diversity of mutual funds might include bonds, commodities, and other investments. You might find investments that perform better when the stock market is low, which can help reduce volatility in your portfolio.
Return on Investment vs. Return of Investment
A key distinction to be made when checking mutual fund returns is the difference between the return on investment (ROI) and return of investment. The actual return that the investor receives is called the return on investment (ROI). The return of investment is the actual investment's return. These returns can vary, and they are often confusing. Many investors use a systematic investment plan to make periodic investments such as mutual fund purchases. This method of investing is sometimes called dollar-cost average (DCA) and can often result in an investor's ROI being different from the mutual fund's stated annual return.
If you use DCA to invest in a stock mutual funds during any year, and the stock market crashes during that period, your ROI will be greater than the annual returns. The annual return, which calculates the price change--NAV in mutual funds, gives this result. It runs from the beginning to the end. Most investors do not make a lump-sum payment on January 1. They make regular investments throughout the year. You've been making purchases at lower prices every month in a year when the market is collapsing. This means that your value had declined compared to if you had made a lump-sum investment right before the crash started.
