Measuring Performance · Mutual Funds
Risk includes the size and timing of losses, not only the average return. Volatility, drawdowns and recovery periods answer different questions about the experience of owning a mutual fund.
Know what volatility measures
Standard deviation describes how widely periodic returns vary around their average. Its value depends on the frequency and sample period. Monthly and daily observations do not produce interchangeable statistics without assumptions. Volatility counts upside and downside variation, so it is not a complete measure of permanent loss or liquidity risk.
Measure drawdown from a prior peak
If a fund's reinvested value rises to $120 and later falls to $90, the decline from that peak is 25%. Maximum drawdown is the largest such peak to trough fall in the measured period. It depends on the observation frequency and history available. A monthly series can miss a deeper loss that occurred between month ends.
Calculate the recovery hurdle
After a 25% loss, a 25% gain does not restore the original value. Moving from $90 back to $120 requires a gain of 33.33%. In general, the recovery gain equals the loss fraction divided by one minus that fraction. A 50% loss therefore requires a 100% gain to recover.
Include the time spent underwater
Two funds can have the same maximum loss but very different recovery periods. An investor with near term spending needs may be unable to wait for a recovery. A historical recovery is not a promise that the next decline will reverse at the same speed, or at all.
Compare risk on matching terms
Use the same dates, currency, reinvestment convention and frequency when comparing funds. Read portfolio risks alongside historical statistics. A recently launched fund may not have experienced a difficult credit or interest rate cycle. A small historical drawdown can reflect a quiet sample rather than a permanently cautious strategy.
Try it yourself
A fund falls from $50 to $40 per unit with no distributions. What percentage gain would restore $50?
Show the worked answer
The loss is 20%, but recovery requires $10 divided by $40, or 25%. The calculation uses the lower value as the new starting point.
Further reading
- SEC Investor.gov: Reading a shareholder report
- SEC Investor.gov: Reading a fund prospectus
- SEC Investor.gov: Asset allocation, diversification and rebalancing
Educational material, not a recommendation to buy or sell a fund. Numerical examples are hypothetical. Fund terms, investor eligibility and tax treatment vary by product, account and jurisdiction.
