Best mutual funds: Risk adjusted rate-of-return



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Risk-adjusted return measure tells you how much a high risk fund would
have earned if it has assumed a lower risk level, and how much a lower
risk fund would have earned if it has assumed a higher risk level. By
comparing funds using this key indicator, you can identify the most
efficient funds within each category.

We calculate RAR in two steps: First, we adjust the fund’s risk to a level
comparable to that of its respective benchmark index. Then, we calculate
the rate of return that the fund would have posted under that assumption.
In other words, RAR gives us the rate of return that the fund manager
would have obtained, had he/she been prepared to assume the same risk
level as the index.

54 comments on “Best mutual funds: Risk adjusted rate-of-return

  1. Well managed mutual funds have more return than expected risk while poor mutual funds take too much risk to get their return. Risk can be explained in 3 ways:

    a) Extreme High Risk – What's the chance that you will lose your $2 lottery ticket in a bid to win the $50 million jackpot? It is extremely certain that this will happen. In such a scenario, risk adjusted return cannot be computed because the risk far outweighs the actual reward expected. Examples of investments with extremely high risk are gold & precious metals mutual funds and individual stocks.

    b) Middle Risk – Most investment grade mutual funds & bonds, blue-chip stocks and ETFs have middle risk. For instance, if you are invested in investment grade stocks like AAPL or IBM, those companies could perform well in a given year or perform poorly depending on their business & industry cycle, thus you should expect a similar level of reward for the risk you are taking.

    c) Extreme Low Risk – This applies to money market instruments & guaranted certificates of deposit. The return of 1% you get from a GIC is low but such investments have almost NO risk whatsover, you get what you pay for!


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