Lots and lots of investors make considerable use of mutual funds in their portfolio.
As with everything in life and in investments – the need to use mutual funds in an investment portfolio has different views. Many years ago, I thought that using mutual funds in an investment portfolio only detracted from performance and therefore I avoided.
Today, with much more experience and advanced technology and with advanced products and measurement methods available and accurate – I see mutual funds as an investment tool required in the investment portfolio is high. The level of exposure to mutual funds will of course be in accordance with the nature of the investor. For most investors it can certainly fit in and I see no reason why an "ordinary" investor will not use one or another mutual funds.
There are hundreds of funds in the Israeli capital market and thousands of other funds around the world.
I divide their character into two main categories: imitative fund and active fund.
A mimicking fund, similar to ETFs, monitors the relevant index and strives to present the index's performance independently of management capabilities. An excellent investment device that does the job in most cases and with low costs.
An active fund is working to achieve yields that exceed the indices of the ratio it chose to belong to, and here comes the method of calculation that some investors are not aware of.
When I invest in an active fund, it is reasonable to assume that I will pay high management fees in exchange for management. Has a fund manager and is constantly working to present as high returns as possible in accordance with the fund's investment policy.
So I chose a certain mutual fund and it earned in the period I held – 10%. It is good? it's bad?
I do not intend to enter all the risk indices to be calculated or to be addressed. Except for two simple measures that should be taken into account when choosing a mutual fund – the ratio index and the industry average index!
The ratio index
The ratio index is a measure that the trust fund chose to stick to. This is one of the stock market indices. For example, the Tel Aviv 35 index, the Tel Bond 20 index, and so forth.
Note that the return on your mutual fund is not on its own. If the fund has managed to earn 10% it may be nice but it is necessary to check the return of the ratio index as the fund defined its affiliation. Since we pay quite a few management fees to the mutual fund, we are looking for results that exceed the ratio index. Therefore, the absolute return of the principal is irrelevant.
If my mutual fund has earned 10% a year but the ratio index has increased by 15% I understand that the trust fund has failed significantly. I chose an active fund in order to produce a yield that is higher than the ratio index and received less favorable results.
Of course, the index also works on the other side. My fund lost 10%, but the ratio index fell by 15%. I understand that the trust fund did its work faithfully.
Another positive event – the mutual fund increased by 10%, while the ratio index rose by 5%. The trust fund did its job faithfully.
Industry average index
The industry average index enables us to examine the performance of the mutual fund vis-a-vis its similar sisters. There are quite a few mutual funds under the same category of investment (stocks, bonds, a combination of both), so from many funds operating under the same definitions can be derived from the average and therefore tap on the performance of our mutual fund.
If our mutual fund has achieved a return of 7% and the industry average has achieved double-digit returns, the fund has failed significantly.
If our mutual fund has achieved a yield of 7% and the industry average has returned 3%, our fund does the work for us.
When a fund imitates a fund, it must be noted that the fund has indeed erased the index to which it belongs. When an active fund is involved, the yields must be examined according to the ratio index and according to the industry average index. The fund's yield is insufficient.
When it comes to an active fund, I suggest examining the fund's performance over time. It is very possible that in a given year a mutual fund will fail to perform against the ratio indices or against the industry average. Therefore, when I examine the performance of an active mutual fund under the two indices mentioned in this post – I will do so under 2-3 years of back investment. If the fund manages to show performance that exceeds both the ratio index and the industry average over the next two to three years, we will invest.
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