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A critical step in choosing an index fund in which to invest is to evaluate index fund performance. The results of the evaluation will likely influence how much money an investor will dedicate to a particular fund. It is important that investors focus on collecting accurate information on important criteria when making a decision.
Investors evaluating index fund performance must consider many different factors, including historical performance, management fees, tax implications and investment strategy. An investor should consider all of these factors together and also compare the rate of return. The historical performance of a fund can give an indication of the management’s skill and the fund's possible future performance. Investors should compare how an index performs against other index funds and other well-regarded indices, such as the Standards & Poor 500 and the Dow Jones Industrial Average.
One important aspect of index fund performance is management fees. Two types of fees are included in management fees. One fee is for the people who manage the fund and the second fee is for trading securities. Depending on the strategy, the index fund may make several trades or only a few. Each trade incurs a transaction fee, so a fund’s management fee will be higher if it trades often.
It is important to note that mutual funds often perform as well as a market index after the management fee is taken into account. Very rarely can index funds consistently outperform the market after fees. Based on this, many investors choose to invest in total stock market index funds that mimic an index, require less research to maintain and charge lower fees.
Investors wanting to correctly evaluate index fund performance should consider the tax consequences, paying attention to the turnover rate, or how often a fund trades stocks. Index funds with a higher turnover rate will incur more capital gains taxes, and dividends received are also taxed. Investors should also read what analysts say about indices and markets, because analysts have access to better information and understand financial markets better than the average investor, making what analysts report pertinent to investors. Analyst reports often offer well-reasoned insights as to what works within a given market and where the market is headed.
Some argue that the most important aspect in evaluating the performance of any investment is determining if the investment is in accordance with the overall investment strategy. For instance, investors focusing on low-risk funds would not want to choose a fund with an extremely high return, because the fund most likely invests in risky assets and has volatile performance. After deciding on a strategy, an investor should be resilient and calm. The market will fluctuate in the short term, which is no cause for alarm. Only if the performance over several quarters is below average should an investor consider changing his strategy.