Mutual funds can offer a streamlined way to build an investment portfolio. Rather than purchasing individual stocks or bonds, you can buy mutual fund shares to gain exposure to multiple investments in a single basket. Evaluating the quality of mutual funds means looking at different factors, including its expense ratio, the fund manager’s track record and its past performance. Trailing returns can tell you how a fund has performed over a set time frame, though they aren’t a guaranteed indicator of a fund will perform in the future.
Trailing Returns, Definition
Trailing returns measure how well a mutual fund has performed over a specific time period. It’s not uncommon to see trailing returns measured on a one-year, three-year, five-year or 10-year basis. Trailing returns can also be calculated from the current date all the way back to the fund’s inception date.
Using trailing returns to measure performance allows you to get a snapshot of a mutual fund at a specific point in time. As such, they can also be referred to as point-to-point returns since you’re looking at performance between a starting point and an ending point. Trailing returns are a fairly simple way to evaluate mutual funds since you’re simply charting and measuring price movements that have already occurred.
How Trailing Returns Are Calculated
Trailing returns follow a specific formula for calculations. The formula uses a mutual fund’s net asset value as its basis for calculations. Net asset value (NAV) is the per-share market value of a mutual fund. It’s determined by dividing a mutual fund’s cash and securities minus liabilities by the total number of outstanding shares. In short, NAV tells you what a mutual fund’s shares are worth.
To find the trailing returns, you would find the current net asset value then subtract it from the net asset value for the beginning of the time period you want to measure. You’d then divide that number by the original value and multiply the result by 100.
For example, say you’re considering a mutual fund that has a current net asset value of $20. You want to measure trailing returns for the previous five-year period. The original value for that time frame is $15. So you subtract $15 from $20, divide by $15 and multiply by 100 to get a trailing return of 33%.
Trailing Returns vs. Rolling Returns
In addition to trailing returns, you can also calculate rolling returns for mutual funds. Rolling returns represent the average annualized return for a set time period. But they can offer a more comprehensive picture of a fund’s performance compared to trailing returns. With rolling returns, you’re not focusing on a single one-, three- or five-year period. Instead, you’re comparing several blocks of time to see how a mutual fund performed at different points in its history. So you may look at a fund’s three- or five-year performance at varying intervals since its inception date to use as a basis for comparison.
Rolling returns can provide a more accurate view of a mutual fund’s performance because they aren’t limited to a fixed point in time. Trailing returns, by comparison, limit your view to one specific time frame. The danger of using trailing returns alone to evaluate fund performance is that you could easily fall into the recency bias trap. This bias can lead investors to give more weight to a fund’s recent performance history than its older performance history.
Using rolling returns to measure a fund’s performance can help you see where the peaks and valleys are over time. For example, if you’re using a five-year time frame to measure rolling returns you could determine which five-year periods were the best or the worst for that fund. Rolling returns can keep you from falling victim to recency bias since you’re looking at the fund’s full historical picture.
Using Trailing Returns to Evaluate Mutual Funds
If you’re looking at trailing returns to compare mutual funds, there are a few things to keep in mind.
First, remember that this is simply a measure of how a fund has performed over a single time period. And it doesn’t guarantee that the returns earned over that period will be replicated in the future. This is particularly important to be aware of during periods of increased market volatility, especially when that volatility is due to unusual circumstances such as a global pandemic.
Next, remember that even if a fund continues to perform the same way it has in the past based on trailing returns, your actual return can vary. If a fund increases its expense ratio over time, for instance, that can affect the returns that investors get to keep.
Returns can also be affected by when you buy into a particular investment. If a particular fund tends to do better during certain times of the year, for instance, and you buy in during the “off-season” then you may miss out on the fund’s best performance periods. (Be careful, though, not to fall into the trap of market timing as you seek to coordinate your purchase or sale of a fund with expected up or down seasons.)
This is why comparing rolling returns alongside trailing returns can give you a more accurate idea of what you can expect from a particular fund that you may be interested in buying. With rolling returns, you can see how a fund has reacted to changing market conditions over time. Looking at both can make it easier to determine how well a fund may align with your needs and goals when deciding where to invest.
The Bottom Line
There are many ways to evaluate a fund’s past and its prospects. Trailing returns can tell you where a mutual fund has been, historically, though they aren’t absolute predictors of where a fund will head next. While you can use trailing returns as a baseline for evaluating funds, it’s also important to consider rolling returns as well for a more detailed estimate of a fund’s performance.
Tips for Investing
- Consider talking to a financial advisor about trailing returns versus rolling returns and how to best evaluate mutual fund performance. If you don’t have an advisor yet, finding one doesn’t have to be difficult. SmartAsset’s financial advisor matching tool can help you connect quickly with professional advisors in your local area. If you’re ready, get started now.
- If you’re interested in maximizing investment returns with mutual funds, pay close attention to management fees and tax efficiency. Placing funds with higher turnover ratios inside a tax-advantaged account such as an individual retirement account (IRA), for example, could help with minimizing taxes. At the same time, you could invest in low-turnover mutual funds or exchange-traded funds inside a taxable brokerage account.
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