Let’s break down the metrics and details that every person who invests in their company’s retirement plan should pay attention to.
- Expense Ratio: How much of a fund’s assets are used for administrative and operating expenses such as fund-manager compensation and auditing fees. The expense ratio represents these costs as a percentage of the fund’s total assets. Lower is better, all else being equal.
- Weighted Average P/E Ratio: The price-to-earnings ratio is the measure of the share price relative to the annual net income earned by the firm per share. The P/E ratio shows current investor demand for a company share. It has units of years, which can be interpreted as the number of years of earnings required to pay back the purchase price. Lower is better, all else being equal.
- Total Return: The actual rate of return of an investment over a given period. Total return includes interest, capital gains, dividends, and distributions over that time. Higher is better, all else equal. It is important to look over several time periods and during various economic periods—booms, busts, and everything in between.
- Alpha: A performance measure that indicates the excess return of an investment against a chosen market index or benchmark. Higher is better. This metric measures a strategy’s ability to “beat” the market. A positive alpha indicates a better return relative to the benchmark; a lower alpha means the investment performed worse than it should have given the return of its benchmark.
- Sharpe Ratio: A measure of risk-adjusted return for a given investment. The Sharpe ratio isolates an investment’s profits associated with risk-taking activities. Higher is better.
- Maximum Drawdown: An indicator of downside risk over a specified period. Maximum drawdown is the maximum observed loss from a fund’s peak to its trough before a new peak is reached. Lower is better, all else being equal.
- Underlying Holdings: Understand what the fund actually holds and in what percentages.
- Asset Allocation: Know what sectors and geographic regions the fund is invested in.
By identifying and understanding these metrics for evaluating funds, you are one step closer to finding the best funds to invest in to help you reach your financial goals.
-Paul R. Rossi, CFA