Investors who pay attention only to an investment’s return are missing out on valuable information. Determining how it achieved its returns can be just as important as analyzing the returns themselves. Evaluating an investment candidate properly not only helps you compare it to its peers; it lets you see whether it matches your investing needs and how it would complement your other investments. If you’re in the market for a fund or other investment vehicle, ask yourself these three questions before you decide:
What is the investment objective?
For some investors, analyzing a potential investment basically consists of looking at historical returns. However, any analysis really should start with its investment objective. More than any other factor, this will determine the role a specific product might play in your portfolio and how well it fits with your financial goals.
There are three basic investing objectives: growth, income, and capital preservation. Growth investments are typically expected to appreciate over the long term. Income investments offer regular payments of income. Investments that focus on capital preservation won’t increase much in value, but they are the least likely to lose value and can be easily converted into cash. Within each category, a product may have various ways of achieving its objective. It may also combine objectives; for example, the Azzad Wise Capital Fund (ticker: WISEX) focuses on capital preservation and income.
What is the investment style?
Even products that invest in the same type of securities and have a similar investment objective may have different ways of trying to achieve that objective.
One point of differentiation for stock portfolios is whether the manager leans toward either value or growth investing. A value-oriented fund focuses on buying stocks that appear to be undervalued by the market relative to the company’s intrinsic worth. A growth fund focuses on companies that are growing quickly and seem to have greater than average potential for appreciation in share price. The Azzad Ethical Fund (ticker: ADJEX) falls into this category, as do several of our separately managed accounts.
What do the metrics show me?
Once you’ve decided whether an investment’s objective and style make it a good potential candidate for your portfolio, it’s time to look at metrics that can help you determine how successful it is at achieving its goals, and what you might expect as an investor. Though past performance is no guarantee of future results, information on such metrics as returns, risks, volatility, and expenses can give you a basis for comparing one investment to another. Carefully consider not only returns, but also how it achieved those returns.
When evaluating an investment’s performance, make sure you’re comparing it to an appropriate benchmark, or to products that have similar investment objectives and that invest in similar securities. For example, comparing a large-cap stock fund to one that invests exclusively in small-cap stocks won’t give an accurate picture of either one.
Performance is one of the most popular metrics used to evaluate an investment, and justifiably so. When looking at performance, however, consider both short-term returns for specific time periods–for example, a bear market–and longer time periods. Considering only short-term results can be misleading (for example, if a fund’s market segment, asset class, or investing style is temporarily out of favor). Also, be careful about what’s known as “chasing performance”–investing in products solely because they have recently experienced high returns. Those high returns can sometimes (though not always) mean a market sector may be at a peak and about to rotate out of favor, as all sectors do periodically.
Equipped with this information, you’ll be making a better-informed investment decision.