Index Funds Vs ETFs – Which is Better for Long Term Investors?

If you are an investor then you should learn to identify the difference between index funds and Exchange Traded Funds, or ETFs. Index funds are mutual funds that track the movement of a market index, such as the S&P 500. This allows investors to buy a portion of dozens or even hundreds of shares without having to maintain shares of each individual stock. In other words, it is a quick and easy way to diversify your holdings and invest in what the market does.

Both of these types of investments allow investors to purchase a wide variety of companies in one easy to manage investment. There are many index funds and ETFs that follow a number of different markets, from the entire stock market, to a commodity market, to a specific foreign nation’s market.

When you make a sale or purchase of an index fund, your transaction occurs at the NAV (price) at the end of the day. ETFs are investment funds that are traded like stocks. However, unlike mutual funds, they can be traded any time during the trading day and the NAV is effective at the time of the trade. This can make a big difference when there is a major swing in the markets. But it usually doesn’t make a big difference when all is said and done.

But for basic investors who want to buy a total market index, which is better option, index funds or ETFs?

Primary Differences Between Index Funds & ETFs

Hare are the The primary differences are these:

  • Trading: ETFs are brought and sold during the day; index funds, at the end of the day. ETFs are more flexible, but this shouldn’t be a primary concern for long-term investors.
  • Costs: ETF expense ratios are generally cheaper, but not always. Be sure to read the fine print before making investment decisions. Since ETFs are traded like stocks, you’ll need to buy shares through a brokerage, and you’ll incur a commission with each trade. This commission may be $0 at certain discount brokerages, such as E*Trade, which offers over 80 commission free ETFs. Learn how to buy shares through E*trade.
  • Minimum Investment: ETFs have no minimum investment. Index funds may have minimum investments of a $1,000 or even more. Some of the premium index funds may require an investment of more than $10,000. The minimum investment requirements are usually lower for retirement accounts.
  • Pricing: ETFs are, again, like stocks. There is a bid-ask spread that marks the difference between the price that buyers are offering (bid) and the price that sellers are offering (spread), which is higher than the bid. When a transaction occurs, the buyer and seller split the difference. The bid-ask spread, then, generates a hidden cost that index funds don’t incur. (There is also a risk that an ETF trades at a premium or discount to its net asset value due to market forces, but arbitrage mechanisms – traders who notice this difference and will trade to profit from the discrepancy – usually bring the price back in line with the NAV.)
  • Dividend Reinvestment: It’s easy to reinvest dividends in an index fund. However, it isn’t do this with an ETF. Some stock brokers feature automatic Dividend Reinvestment Plans (DRIPs), but others don’t. If your brokerage features DRIPS, you may be able to reinvest your dividends without an additional transaction fee. Otherwise, you may have to pay to reinvest your dividends.
  • Taxes: Some ETFs are more tax efficient than index funds. You’ll still have to pay taxes on dividends and capital gains, but you have control over the timing of the capital gains distribution. With index funds, when any shareholder liquidates his stake, fund managers will have to sell shares to raise the money. This generates recognized gains, which are distributed on to the remaining fundholders, who will have to pay taxes on the gains. ETFs also have the added advantage of being able to trade stocks through “in-kind” transactions, which allow them to rebalance their portfolios without incurring capital gains on those transactions.

Index Funds Vs ETFs – Verdict:

Depending on your trading habits, ETFs may be the better bet as long as the commissions aren’t too high. ETFs are easier to trade, generally have lower expense ratios, do not have minimum investment requirements, and are often more tax efficient. If you invest through a discount brokerage or only buy ETFs that don’t have transaction fees, you can generally come out ahead over the long run. But if you invest on a monthly schedule, then you might want to consider a mutual fund, which generally won’t have any associated transaction fees.

Here is the most important thing to remember: index funds and ETFs are both great ways to diversify quickly and cheaply, and the sooner you start, the more you’ll gain.


Invest In What You Know

A good investor wants to reap the rewards of good choices, and this is why a good investor will tell you to only invest in what you know best. This is the first step in improving your chances for having a successful portfolio that yields dividends and solid investment returns.

Having the Investment Advantage

Invest in what you know best
Always invest in what you know best

While you may understand how a company works investment-wise by looking at their revenues and growth percentages, you definitely have an advantage when you understand the things about a business that are not so obvious. When you really know a company’s products or their target customers, you understand the ins and outs of the industry and can comprehend what factors will help a company perform great or not-so-great.

Your comfort level with an investment certainly gives you an advantage when making decisions. Your confidence in what you know helps you to make better, more educated decisions. If you are always second-guessing your decisions in markets you don’t know, it is likely you will not find the same successes.

What You Don’t Know CAN Hurt

The old adage, “what you don’t know can’t hurt you,” doesn’t apply to investing. in fact, the opposite is true. When you are dabbling in uncharted territory, there is higher risk of making mistakes with your investments. You are also likely to fall for schemes and scams that will rob you of your time, patience, and ultimately your hard earned money.

Investment scams aren’t new but they are becoming more complex and harder to detect, especially if you are playing on a field where you are not familiar. Scam artists are great at what they do and can make a pitch so believably good, you have no choice but to throw money their way. When you don’t stick with what you know, you are likely a prime target for an investment fraud scheme.

Start With the Basics

There are literally thousands of unique investment opportunities out there. Start by investing in what you know, then branching out to other types of investments as you grow and learn. For example, if you understand the precious metals market, then you may consider buying gold, silver, or other precious metals as an investment. If you understand the stock market, or the general principles, then consider buying stocks and bonds. The same thing goes for an investment such as real estate.

If you are nervous about putting in too much money into any one investment, then consider buying funds, which offer more diversification and spread your risk profile better than you can do if you buy individual investments. You can invest in a variety of funds which tackle different market segments, including gold and precious metals mutual funds or ETFs, stock and bond funds and ETFs, or REITs for real estate investments.

The point is to start small, and expand your investment profile as you learn.

Photo credit: digitalmoneyworld


Retirement Planning with a Roth IRA – Why You Should Start Now

Each person in the workforce, regardless of occupation, age, or earnings shares a common goal: retirement.

The irony of the situation is not lost on many people who realize that one of the most important goals a person can set when they enter the workforce is how they will save for the day they will exit the workforce.  Think about that for a moment.

Of course it is important to have other career goals. You don’t want to spend your entire adult life counting down the days until you no longer have to work.  Nevertheless, retirement planning is essential to ensure you are able to live comfortably when the paychecks stop rolling in.  Let’s look at some important factors that must be considered when you are planning for your retirement.

Retirement Planning – Start Now

You need a Roth IRA
You need a Roth IRA

If you haven’t yet begun the process of saving for retirement, you must start now.  This is true for people in their early 20’s or people in their late 50’s.  It is, of course, easier for younger people to save for retirement simple because they have more time to grow their money (compound interest is the most powerful force in the universe, after all!).  A person in their early 20’s will have to save less per year to have the same amount or more money than a person who doesn’t start saving until their 30’s, 40’s or beyond.  This is not to say that older people should give up on saving for retirement.  That is definitely not the case as any savings efforts are worthwhile to ensure financial stability in your golden years.  It does mean however that older individuals have no time to waste and must get started saving immediately.

Don’t forget Uncle Sam

There are several different retirement plans available to individuals and couples today.  Many of the popular plans like the 401k or IRA come with certain tax advantages.  When saving for retirement it is important to understand how your savings will be taxed and when, to select the plan that best meets your needs.  One way or the other, the government will expect their cut of your money, therefore it is better to be prepared and plan accordingly than be taken by surprise later.

Use a Roth IRA

Roth IRAs are one of the best retirement planning options for investors because it gives them the power to control how and when they take their retirement withdrawals. Roth IRAs are similar to Traditional IRAs, however, they differ in one major aspect: how and when you investments are taxed. Traditional IRAs offer a tax break now – your contributions are not taxed when you make them, giving you a tax break now. However, your withdrawals in retirement years are taxed. Roth IRAs follow the opposite pattern. Your contributions are made with income which has already been taxed, but your withdrawals are tax free. This gives you the opportunity to grow your next egg without the drag or threat of taxes, and it helps you better plan your retirement years.

There is one more major consideration: Required Minimum Distributions. Traditional IRAs require investors to take a minimum withdrawal once they reach a certain age, regardless of whether or not they need the income. Roth IRAs don’t have such a provision. This makes it easier to plan retirement income.

Understand your Investment Options

With the upheaval in the world of finances in the past few years, many people are feeling less inclined to risk their hard earned money in equities such as stocks and bonds.  Unfortunately, letting your money languish in a savings account is not going to provide the growth opportunities necessary to retire in comfort.  That being said, there is no need to risk it all in the hopes of coming out ahead.  It is important for any individual with long term savings goals to review and consider all of the options available.  If financial planning is not your strong point, you may want to enlist the help of a professional. However it is imperative you always remain in charge of your finances and aware of where your money is and the risks you assume.

Retirement planning is a process that will undoubtedly change throughout your lifetime.  If you have an end goal in mind as well as a plan to reach that goal, you are on the right track toward financial security in your later years.  And a Roth IRA can help you get there in style.


Retirement Planning: A Long-term but Worthwhile Investment

Saving for a pension- It’s not the get rich quick option, and in a tough financial market it may seem like saving for retirement can take a back seat, you’re only young after all. It’s a common fallacy. Don’t be tempted into apathy when it comes to retirement planning, saving a little now could leave you far better off in the future.

Why bother?

Once working life draws to a close many of us would like to enjoy a relaxing and well deserved break as we move into our twilight years, and the sooner you start to prepare and save for a pension income the more generous it is likely to be. There’s no doubt about it, retirement planning is all about the long-haul and in most cases the longer you are able to leave you pension fund invested the greater the level of growth you are likely to see.

You may of course be entitled to social security payments when you retire, and while it is important to investigate all possible income streams that could support you in your old age, social security is unlikely to meet the full cost of living maintaining the standard that you set before retirement. As a result, saving into a retirement pension plan is still important even if you do find that you may be eligible for social security or other state benefits.

Retirement planning

So what can you do to secure your future? You need to investigate you options. There are a number of different ways you can save and invest for retirement, through IRAs or 401(k)s for example, many of which offer excellent tax benefits and exemptions meaning that every dollar you put away is worth that little bit more.

The type of retirement fund most suitable for you will depend on a range of factors including:

  • The age at which you wish to retire
  • The age at which you start your pension saving
  • The risk to return ratio you are comfortable with.
  • Whether you are currently employed and whether your employer will contribute to your savings.
  • How accessible you require your funds to be.

Doing your research now will pay off later, if you are unsure you may want to speak to an independent financial advisor who can help guide you through your options.

Make the most of employer contributions

If you are an employee and your employer is willing to match your contributions to a pension scheme such as a 401(k), put your name down and make the most of the opportunity. Every penny counts and when your employer contributes its essentially like getting a pay rise- it’d be crazy to turn it down!

Plan for a better future

Don’t scrimp on retirement savings now, set a goal, start planning and enjoy a greater sense of security and financial freedom in later life.


What is an Exchange Traded Fund?

An exchange traded fund, commonly referred to as an ETF, is an investment vehicle that is a hybrid between a traditional stock and a mutual fund. An ETF is traded on the open market and often used in an investment portfolio, IRA, or retirement plan such as a 401(k). ETFs offer investors a low-cost way to diversify (or leverage) their investments.

ETFs exist to fill a need for investors by offering a low-cost alternative for investing in broad markets or indexes. Although they been blamed by pundits as contributing to volatile market swings, an ETF can be leveraged in things like the total stock market, the S&P 500, the Euro, bonds, or an industry like banking with one simple fund. And the good thing is that you don’t need a masters degree to understand how to invest with ETFs.

ETFs generally have lower expense ratios than mutual funds because they are not traded as individual shares to investors. Rather, they are sold in large blocks to financial institutions who then sell individual shares to investors. This means less number of trades which translates into lower transaction costs.

ETFs are like mutual funds in that they are made up of other investments like stocks, bonds, or commodities. Each ETF has a specific purpose and the underlying investments within it are continuously adjusted to fulfill that purpose. For example, the Vanguard S&P 500 ETF exists to track the S&P 500 and the SPDR Gold Shares ETF exists to track the commodity of gold. Many of the largest ETFs in existence are tied to a market index like the S&P 500, the Russell 2000, or even a segment like small cap or large cap companies. Others focus on international markets, specific industries, or even currency values.

ETFs are a very good way to diversify a portfolio while enjoying a low expense ratio. With such a wide variety of options tracking a range of indexes, markets, commodities, or industries, it is easy for investors to find an ETF to fill a wide range of investment needs. When trading ETFs, however, investors must be diligent in understanding the risk associated with leveraged funds, a commonly-forgotten fact among investors.


Ethical Investment: A Guide to Investing with Conscience

Ethical investment opportunities can offer you the chance to keep your investments in step with your conscience, but they need not cost you the earth.

The credit crunch has made many more of us sit up and take notice of our money and the way in which it is being dealt with on our behalf. However, according to a recent Yougov poll 55% of UK investors did not understand clearly the companies and causes their investments were supporting, and 36% said that they would like to know more about investments designed to bring social and environmental benefits, as well as good returns.

What are ethical investments?  

The word ethical will mean different things to different people, even in the context of investments, and finding the right ethical investment option will depend on your definition of the term. For example, you may consider investing according to your attitude to environmental or social ills or a combination of both.

You will usually invest through a managed fund where your capital will be pooled and invested on your behalf according to predetermined ethical guidelines. There are usually a range of different funds available on the market offering many different types of ethical investment, you will need to consider these carefully in order to find a fund that is right for you.

It’s always a good idea to know exactly how your money will be invested to ensure that your investments fit with your ethical principles. Do the research and don’t make assumptions based solely on the labeling of an investment product or fund.

Which type of fund?

There are two main types of ethical investment fund, those that use positive screening and those that use negative screening.

Negative screening means that your fund manager will seek to avoid investing in companies that may be associated with practices that you may consider unethical.

Positive screening means that your fund manager will actively pursue investing in companies that have what you may consider to be a positive investment impact.

Some pension funds will also offer an ethical investment option, and you may want to ask your pension provider whether ethical investment option are available to you.

Investing ethically will often mean balancing your desire for a good rate of return with ethical principles that are important to you. Sometimes this will mean sacrificing some of the best investment rates available on the market, but ethical investments can still bring decent rates of return, that, when coupled with peace of mind, can be priceless.


Simple Answers to Questions about Gold

With the price of gold skyrocketing to record levels, many consumers are questioning the wisdom of selling their gold jewelry and coins or tucking them away as an investment. The television and radio hucksters would have you believe that the price never drops, but that’s just not true.

Should You Invest in Gold?

While it’s true the current prices have reached all time highs, between 1979 and 2000 the price dropped by nearly fifty percent. Though gold can have some short-term uses in a broad portfolio, it’s rarely a good candidate for long-term investment because of its volatility. The myth that it will rise indefinitely has many unsuspecting investors buying without the knowledge that gold has a long history of pricing bubbles (times when the price cannot be justified by any rational assessment of the real value it may generate.) Bubbles inevitably lead to a price crash.

Who’s Buying?

Dealers, private owners and scrap collectors are doing a booming business buying the gold that consumers are looking to profit from. These items are then sold to refineries where they’re melted down and its purity determined. The higher the karat, the greater the value: 18 karat gold is 75% pure gold, for example; 12 karat is 50%.

Questions to Ask Before Selling Your Gold?

With the price of gold fluctuating every day, selling your gold at top dollar can be a little tricky but profitable when the price is high. With so many places offering to buy gold, it’s no wonder that consumers are confused as to which way to go. Even eBay has gotten into the act with their new site feature, the Bullion Center. But before you even begin to choose a buyer there are some important questions to be answered to be sure you aren’t going to unwittingly dispose of a pricey piece and not what you think is a hunk of gold.

  • Do you know what you’re selling and its estimated value?
  • Is the item worth more as is than if it were to be melted down and recast?
  • Could it have historic value or be of interest to a collector?

If you can answer these questions and still want to sell, it’s time to find a reputable buyer. In our next post, we’ll share tips on choosing the best buyer for your gold.

About the Author: Noreen Ruth writes for several popular finance websites. She is interested in educating consumers about using credit responsibly and about legislative action that will affect their ability to borrow the money they need. She has contributed hundreds of articles to various online sites that provide content to educate consumers on credit card offers, debt consolidation, loans and other finance related topics.


Retirement Planning is for You

When you think about the future, what comes to mind? You may be planning next summer’s vacation or maybe you’re focusing on your college graduation. Much of what you think about depends on your age and current life situation. One thing that should be on your horizon, regardless of age, is a retirement plan. Time marches on in spite of all you may do to try and slow it down, so planning for your golden years needs to be a priority, no matter how close or far away those years are.

Retirement planning should be for everyone. Once you start working, you need to establish a retirement account. If you’re already well-entrenched in the working world and haven’t begun saving, now is as good a time as any. If you’re closing in on retirement, or hoping to, it’s never too late to start. The point is that a retirement plan can be devised for any adult at any stage in life. You just have to know where to begin.

There is a plethora of advice available from the web, books and other people. Don’t underestimate your own ability to learn and comprehend the world of saving and investing. Take advice from professionals whose opinions you trust. Financial institutions that offer services for investing in retirement have tried-and-true approaches to the world of investing and have retirement consultants who can help design a retirement savings plan that will be tailored specifically to your needs and wants.

You need to consider a few questions when beginning your retirement planning. Think about what kind of lifestyle you currently have and what kind of lifestyle you want to have when you retire. You will need to determine how many people you will be supporting with your retirement income. One question that doesn’t have a definite answer is how long you will live. With advances in medicine, people are living longer than ever, so it’s not unreasonable to expect your retirement to last at least 30 years.

Another question to ponder is how much money you will need to have in your retirement savings when you quit working. That answer greatly depends on your desired retirement lifestyle. It also depends on how much money you currently are capable of setting aside. Don’t forget to plan for future inflation, as well. A terrific resource you can use to help you with these questions is a financial institution that has retirement specialists. These individuals will be able to use the tools at their disposal to help calculate where you are financially and how to get where you want to be at retirement.

You may be concerned about how you can afford to save for retirement right now. Remember that you may have to sacrifice now to have sufficient funds later. One way to make saving for retirement a little easier is to have money taken directly out of your paycheck and deposited into your retirement fund of choice. Also, check with your employer to see if they offer a retirement program where they will match a portion of your contribution into your retirement fund.

Perhaps you’re wondering why you need to save money for retirement in the first place. Maybe you’re planning on working until the day you die. That’s one way of thinking, but not the best planning strategy to use. If your health suddenly takes a turn for the worse, you may have no other option but to retire. With some companies, retirement is mandatory at a certain age. Also, wouldn’t you like to know that your living expenses will be taken care of in your later years? Travel, helping with expenses for grandchildren and donating to charities are just a few items that may be on your bucket list. Review your future goals and plan how to achieve them.

Consider consolidating all your accounts and investments with one financial institution. That one step will go a long way toward simplifying your life. There are excellent banks that offer everything you need in one convenient location, be it locally or online depending on your preferences.

Above all, take control of your retirement planning. You are the only person who can initiate this step, but there are qualified professionals waiting to assist you from here on out. It’s never too late to start saving for your retirement. Any sum of money you set aside today will be more than you would have had otherwise during your later years. This will not only make your retirement more comfortable, but it will add to your current and long-term piece of mind.


The Top 5 Investment Trends for Mid-2011

Investment experts agree: the stock market is in a summer lull. But this doesn’t mean your investments have to stagnate or suffer.

On the contrary, this summer pause presents a great opportunity to appraise the performance of your 2011 investment portfolio to date and strategize where you might want to go from here.

Regardless of whether you consider yourself a big or small investor – or somewhere in between — a smart starting point is to evaluate your portfolio’s history thus far. How does it compare to the international and domestic (U.S.) investing trends forecast for the remainder of the year?  Do you need to make an adjustment?  Do you have the right mix of stocks, bonds, mutual funds, or ETFs? If not, you may well want to make your move now.

Top 5 Global Investing Trends

According to Arbor Investment Planners, Inc., the top five projected global investing trends for the latter half of 2011 are:

  • Energy
  • Health & Environment
  • Food & Nutrition
  • Infrastructure & Commodities
  • Defense

Even a casual observer would note that these five global investing trends can only continue to climb upward in terms of worldwide demand.

Top 5 Domestic Investing Trends

For domestic (U.S.) investments, the main factors to assess are energy, housing, interest rates, employment, and manufacturing. These trends comprise the very heartbeat of the overall U.S. economy.

Citing the latest statistics from Goldman-Sachs, Calculated Risk reports five domestic investing trends for the last two quarters of 2011:

  • Energy
  • Housing
  • Interest Rates
  • Vehicle production
  • Employment

So What Does This Mean for You?

Of course, reputable investment experts are unanimous in their counsel to take a long-term view of trends, and wait out those short-term spasms – and lulls — of the stock market.

That said, a smart investment strategy for the remainder of 2011 (and beyond) will consider these big-picture, long-term trends and forecasts:

Global Forecasts:

  • Commodities should continue to prove a smart long-term investment, as Asian countries are dedicated to building massive infrastructure projects for the next ten to fifteen years.
  • Asian economies have been successfully checked with higher interest rates to slow unsustainable growth, so their stock markets should take off in the coming months.

U.S. Forecasts:

  • While the U.S. economic recovery has not been particularly robust, it is still growing and should not revisit double-digital recession rates.
  • Quantitative easing by the U.S. Federal Reserve has many analysts hopeful that the U.S. market will fare well in the latter half of 2011.
  • After the recent spike, retail gasoline prices are now back to end-2010 levels (and there are reports of some promising statistics for alternative energy investors).
  • The most recent data indicate that the decline in housing may be abating.
  • While bank lending standards remain tight (and in spite of the recent increase in interest rates) financial conditions are relatively easier overall compared to any point in 2010.
  • Automobile manufacturing has rebounded, as it recovers from Japan’s earthquake and tsunami.
  • Most recent numbers show the unemployment rate is easing back to 9.9-percent.

So it appears that both the international and domestic stock markets are projected to be bullish. This summer siesta presents a fantastic opportunity to revisit and revise your stock investments to take advantage of the positive trends forecast for the rest of 2011.

Of course, it is always a good idea to consult with your financial advisor or trusted online resource before making any substantive decisions about your investments. As chameleon as the market can be, you want to be sure you’ve the latest and most accurate information.


Important Ratios for Mutual Funds

Mutual funds can confound us with their variety and objectives. There are a plenty of mutual funds which can fit all hues of risk and reward combination. While the varieties offer more options to choose from, the same varieties can confuse investors if they do not know how to understand them. Understanding the proportion of equity, objectives, and your own goal and investment horizon are very important to make the most of the fund.

Since most of the retail investors do not have time and expertise to understand the stocks and businesses behind them, they find a responsible advisor in fund manager. Mutual funds diversify the investment into various equities and bonds and thus reduce the risk entailed in the case of individual stocks. Though diversification reduces returns it reduces risk, which is an important parameter from a retail investor’s perspective.

In this article, we will focus on the important ratios concerning mutual funds (note, many of these will also apply to Exchange Traded Funds).

Ratios for mutual funds

Just like stocks, mutual funds have their own ratios that the investors need to look at to judge the investment worthiness of a fund. These ratios will help retail investors understand some of the key factors that impact their returns from mutual funds.

Expense Ratio

Expense ratio is the cost incurred in running the fund by the investment fund house. The expense ratio is calculated by dividing the operating expense by Total Net Asset Value of mutual fund. It is given in %. The figure is also expressed in bps, which is a multiplication by 100 of percentage figure.  The expense ratio is a very important parameter as the expenses are taken from the returns and hence it lowers the returns that the fund earns. A point to be noted here is that a fund takes out this amount regardless of the profit margins i.e. even when the fund runs in losses.

Expense ratio is usually less for index funds since the fund manager doesn’t need to do more research, but just needs to track a market index.

So once you have shortlisted a sector and a few funds in that sector choose a fund which has least expense ratio for investment.

Load structure

The entry load is the initial charges taken out by the fund from your investment. Hence when you buy the mutual fund, you don’t get fund units worth full value of your money. The exit load is when you sell fund units you have to pay the exit load.

As the definition specifies, it’s better to choose lower load funds.

Portfolio PE ratio

The PE ratio of mutual fund is price by earnings ratio. It simply tells you how much you are paying to earn Rs 1. If the PE ratio is 25, you are paying Rs 25 to earn Rs 1, a 4% return. This is certainly making things too simplistic as the earnings will keep growing for the companies which are part of the mutual fund. There is no hard and fast rule but a PE ratio of 20 and less is preferable. The other side is that a high PE ratio indicates that people are ready to pay higher price for the fund because the market believes that the fund value can grow faster.

Portfolio PB Ratio

The PB ratio of a mutual fund is aggregated price to book ratio of all the stocks and entities comprising the fund. The PB ratio tells you the price you are paying for a unit book value. The book value is another topic which can take many pages. Suffice it to say that book value is nothing but the value of all the assets minus the liabilities. There is no specific value which can be used to measure attractiveness of a mutual fund.

Dividend Yield

Dividend yield is the dividend distributed by the mutual fund as % of the current market price of the fund. For example,  a dividend yield of 3% and more will be great offer in Indian market as Indian companies usually do not give good dividends. The reason is not difficult to guess. India is a growing economy and most of the firms are growing faster. The companies need money to fuel the growth and hence most of the companies invest the earnings in growing the company than distributing it as dividends.

Market Cap

The market cap shows whether the fund has invested in large cap, medium cap, or small cap. The very large market cap shows that the fund has invested in blue chip companies with very large market capitalization.

Market cap helps investors realize the risks and rewards that they should expect from the fund. A large market cap fund that invests in blue chip companies will give average returns with very less risk.


Beta of the fund shows the measurement of risk of mutual fund with respect to the market. In simple language, it tells you how much a mutual fund’s NAV will move for a certain move of the market index.

If a mutual fund has a beta of 1.2, it means it will move 1.2 times the market’s move. So if the market moves up by 10%, the mutual fund’s value will move up by 12%. If the market goes down by 20%, the mutual fund’s value will go down by 20*1.2 = 24%.

A beta of -1.2 means that the mutual fund and market move in opposite direction with mutual fund moving more. For example, if market moves up by 10%, the mutual fund’s value will move down by 12%.

Sharpe ratio

Nobel laureate, Bill Sharpe, devised a formula known as Sharpe Ratio. This ratio measures the returns with respect to risk taken by the fund. The formula is return of fund in excess of the risk free return divided by the standard deviation of its returns.

Sharpe ratio = (Return of the fund – risk free return) / standard deviation of the return of the fund

A higher Sharpe ratio is preferable as it denotes higher returns for the risk taken. A negative Sharpe ratio indicates that the fund is performing worse than a riskless asset.

Standard deviation

Standard deviation of a fund is measure of its volatility. A high volatility shows the risk is high. However, as we have just shown above Sharpe ratio is a better measure than just looking at standard deviation in isolation.

The last words

These ratios are very important for investors to know. Most of the mutual funds scheme document will provide the ratios anyway so investors do not have to calculate them. Look at the ratios and decide for yourself. In the end, these ratios will drive the performance of the fund.