DISCLAIMER:
THE INFORMATION PROVIDED IN THIS ARTICLE IS FOR EDUCATIONAL AND INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE CONSIDERED FINANCIAL ADVICE. MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READERS ARE ADVISED TO CONSULT WITH A CERTIFIED FINANCIAL ADVISOR BEFORE MAKING ANY INVESTMENT DECISIONS. THE WEBSITE OWNER IS NOT RESPONSIBLE FOR ANY FINANCIAL LOSSES OR OUTCOMES BASED ON THE CONTENT PRESENTED HERE.
MEET RAJESH – A FIRST-TIME MUTUAL FUND INVESTOR
RAJESH, A 30-YEAR-OLD OFFICE WORKER, RECENTLY STARTED THINKING ABOUT INVESTING. HIS COLLEAGUE TOLD HIM ABOUT MUTUAL FUNDS, SO RAJESH GOT CURIOUS. BUT WHEN HE OPENED A FEW FUND WEBSITES, HE SAW STRANGE TERMS LIKE SHARPE RATIO, ALPHA, BETA, AND EXPENSE RATIO.
RAJESH WAS CONFUSED.
SO, HE DECIDED TO LEARN THESE RATIOS WITH SIMPLE EXAMPLES, JUST LIKE A STORY.
CHAPTER 1: THE EXPENSE RATIO – “THE FEE YOU PAY”
IMAGINE YOU WANT TO EAT AT A RESTAURANT. YOU PAY FOR THE FOOD PLUS SERVICE CHARGES. SIMILARLY, WHEN YOU INVEST IN A MUTUAL FUND, THE EXPENSE RATIO IS THE SERVICE CHARGE FOR MANAGING YOUR MONEY.
SIMPLE DEFINITION:-
IT TELLS HOW MUCH THE FUND HOUSE CHARGES YOU YEARLY TO MANAGE YOUR INVESTMENT.
EXAMPLE:-
IF YOU INVEST ₹1,00,000 IN A FUND WITH A 2% EXPENSE RATIO, YOU PAY ₹2,000 PER YEAR.
RAJESH’S THOUGHT:-
“OKAY, SO LOWER EXPENSE = MORE RETURN FOR ME. GOT IT!”
CHAPTER 2: SHARPE RATIO – “RETURNS WITH RISK”
RAJESH ASKED, “IF TWO FUNDS GIVE THE SAME RETURN, HOW DO I KNOW WHICH ONE IS BETTER?”
ENTER THE SHARPE RATIO – IT SHOWS HOW MUCH RETURN THE FUND GIVES AFTER CONSIDERING THE RISK.
SIMPLE DEFINITION:-
HIGHER SHARPE RATIO = BETTER RETURNS PER UNIT OF RISK.
EXAMPLE:
FUND A: RETURNS 12%, RISK (STANDARD DEVIATION) = 6%
FUND B: RETURNS 12%, RISK = 3%
SHARPE RATIO WILL BE HIGHER FOR FUND B. WHY? LESS RISK FOR SAME RETURN.
RAJESH’S THOUGHT:-
“SO, HIGHER SHARPE = SMARTER FUND. I’LL REMEMBER THAT!”
CHAPTER 3: ALPHA – “THE EXTRA BONUS”
RAJESH THEN SAW ALPHA IN FUND REPORTS.
ALPHA IS LIKE YOUR FUND MANAGER GIVING YOU A SURPRISE BONUS.
SIMPLE DEFINITION:-
IF A FUND SHOULD HAVE GIVEN 10% RETURN BUT GAVE 12%, THE ALPHA IS +2%.
IF IT GAVE ONLY 8%, ALPHA IS -2%.
RAJESH’S THOUGHT:
“POSITIVE ALPHA? THAT MEANS THE FUND MANAGER DID A GREAT JOB!”
CHAPTER 4: BETA – “THE MOOD SWING METER”
IMAGINE BETA AS A MOOD SWING METER. IT TELLS HOW SENSITIVE YOUR FUND IS TO THE STOCK MARKET.
SIMPLE DEFINITION:
BETA = 1 → SAME UPS & DOWNS AS THE MARKET.
BETA < 1 → LESS UPS AND DOWNS.
BETA > 1 → MORE UPS AND DOWNS.
EXAMPLE:
IF SENSEX FALLS 10%,
FUND A (BETA = 1) FALLS 10%
FUND B (BETA = 0.8) FALLS 8%
FUND C (BETA = 1.2) FALLS 12%
RAJESH’S THOUGHT:-
“LOW BETA = BETTER FOR ME. I DON’T LIKE ROLLER COASTERS!”
CHAPTER 5: STANDARD DEVIATION – “HOW UNSTABLE IS IT?”
STANDARD DEVIATION (SD) TELLS HOW MUCH YOUR RETURNS BOUNCE AROUND. HIGH SD = MORE FLUCTUATION.
EXAMPLE:-
FUND A GIVES 10%, 11%, 9% → LOW SD
FUND B GIVES 5%, 15%, 10% → HIGH SD
RAJESH’S RULE:-
“FOR STABLE RETURNS, I’LL PICK A FUND WITH LOW SD.”
CHAPTER 6: R-SQUARED – “HOW CLOSE TO THE BENCHMARK?”
R-SQUARED TELLS HOW MUCH YOUR FUND FOLLOWS ITS BENCHMARK INDEX (LIKE NIFTY OR SENSEX).
100% = MOVES EXACTLY WITH THE INDEX
80%+ = GOOD
< 70% = NOT SO RELIABLE IF YOU’RE COMPARING WITH THE MARKET
RAJESH’S THOUGHT:-
“IF I WANT INDEX-LIKE PERFORMANCE, I’LL LOOK FOR HIGH R-SQUARED.”
CHAPTER 7: TREYNOR RATIO – “RETURNS PER RISK (BETA)”
TREYNOR RATIO IS LIKE SHARPE RATIO, BUT IT USES BETA INSTEAD OF OVERALL RISK.
EXAMPLE:
FUND RETURN = 12%, RISK-FREE = 6%, BETA = 1.2
TREYNOR = (12-6)/1.2 = 5
HIGHER TREYNOR = BETTER RISK-ADJUSTED RETURNS (FOR MARKET RISK ONLY).
CHAPTER 8: SORTINO RATIO – “ONLY DOWNSIDE RISK MATTERS”
SHARPE LOOKS AT TOTAL UPS AND DOWNS.
SORTINO RATIO ONLY CONSIDERS BAD (DOWNSIDE) FLUCTUATIONS.
GREAT WHEN YOU ONLY CARE ABOUT THE CHANCES OF LOSING MONEY.
RAJESH’S FINAL NOTE:-
“FOR CONSERVATIVE INVESTING, I’LL FOCUS ON THE SORTINO RATIO.”
SUMMARY TABLE – RAJESH’S HANDY REFERENCE
| RATIO | WHAT IT MEANS | WHAT’S GOOD? |
| EXPENSE RATIO | FUND’S ANNUAL COST | LOWER |
| SHARPE RATIO | RETURN VS TOTAL RISK | HIGHER |
| ALPHA | EXTRA RETURN OVER BENCHMARK | POSITIVE |
| BETA | FUND’S VOLATILITY VS MARKET | DEPENDS (LOWER FOR SAFETY) |
| STD DEVIATION | OVERALL RISK | LOWER |
| R-SQUARED | SIMILARITY WITH INDEX | HIGH (80%+) |
| TREYNOR RATIO | RETURN PER MARKET RISK (BETA) | HIGHER |
| SORTINO RATIO | RETURN PER DOWNSIDE RISK | HIGHER |
FINAL WORDS FROM RAJESH
AFTER LEARNING ALL THESE RATIOS, RAJESH FELT CONFIDENT.
NOW HE COMPARES FUNDS SMARTLY, NOT JUST BASED ON RETURN.
MORAL OF THE STORY:-
BEFORE YOU INVEST, CHECK THESE MUTUAL FUND RATIOS LIKE RAJESH DID – AND INVEST WISELY!
THANKS.
