Mutual funds are oftentimes seen as safe and boring investments that anyone can invest in. But like any investments, even mutual funds carry a certain degree of risk to them and investors, especially new ones, should do their due diligence before putting their hard-earned money into any mutual fund schemes. Now, the question arises how exactly would an investor assess the potential and risk of any mutual fund scheme? One answer to this can be the use of mutual funds fact sheets. It is an important document that provides a summary of the fund and its performance. This study is useful for potential investors who want to appraise mutual funds and learn about their benefits and drawbacks. Through concise statements, visuals in the form of charts, ratios etc a fact sheet present a straightforward and accessible image of the fund. It gives the investor a solid concept of a specific mutual fund, allowing them to take the initiative toward deciding whether or not to invest in one. Not to mention, understanding some basic ratios is very important to understand the fact sheets and in turn, understand the risks and potential involvement in investing in any particular mutual fund scheme.
Ratios are basically the division of one variable by another. They're commonly employed in financial analysis to figure out how corporations, funds, and other investments are performing internally and in comparison to one another. Let us take a look at some of the most important ratios that investors should look at before actually investing in a mutual fund.
1. Portfolio Turnover Ratio- This ratio is the rate at which portfolio managers buy and sell assets in a fund. To put it another way, the portfolio turnover ratio is the percentage change in a portfolio over a one-year timeframe. The portfolio turnover ratio is an important factor to consider before investing in a mutual fund or another financial instrument since it influences the fund's investment performance. A reduced turnover ratio is preferable to a high turnover ratio in general.
2. Expense ratio- This ratio is a cost imposed by an investment firm for managing the funds of its shareholders. When managing clients' assets, investment businesses such as mutual funds incur a variety of operational expenses, which they offset by charging a tiny proportion of the assets under management.
3. Sharpe Ratio- This ratio (which is named after William Sharpe- an American economist) helps to measure a mutual fund’s performance in comparison to the risk taken by the said fund to achieve those returns. A higher Sharpe ratio indicates that the investment is a sensible one as it means that the returns derived in comparison to the risk taken are pretty high too.
So, these are some of the most important ratios that any investor who is looking to invest in a mutual fund should look at and understand to ensure that they are making an informed and sensible investment.
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