Three questions to ask when shopping for an investment

Investors who pay attention only to a fund’s return are missing out on valuable information. Determining how a fund achieved its returns can be just as important as analyzing the returns themselves. Evaluating a fund properly not only helps you compare it with other funds; it lets you see whether a fund matches your investing needs and how it would complement your other investments. If you’re in the market for a mutual fund or other investment vehicle, ask yourself these three questions before you make a decision:

What is the investment objective?

For some investors, analyzing a mutual fund basically consists of looking at historical returns. However, any analysis really should start with a fund’s investment objective. More than any other factor, this will determine the role a specific fund might play in your portfolio and how well it fits with your financial goals.

There are three basic investing objectives: growth, income, and capital preservation. Growth investments are typically expected to appreciate in value over the long term. Income investments offer regular payments of income. Investments that focus on capital preservation won’t increase much in value, but they are the least likely to lose value and typically can be easily converted into cash. Within each category, a mutual fund may have various ways of achieving its objective. A fund also may combine objectives; for example, the Azzad Wise Capital Fund (ticker: WISEX) focuses on capital preservation and income.

What is the investment style?

Even funds that invest in the same type of securities and have a similar investment objective may have different ways of trying to achieve that objective.

One point of differentiation for stock portfolios is whether the manager leans toward either growth investing or value investing. A growth fund focuses on companies that are growing quickly and that seem to have greater than average potential for appreciation in share price. A value-oriented fund focuses on buying stocks that appear to be undervalued by the market relative to the company’s intrinsic worth. Some fund managers blend the two approaches; this is sometimes known as a “growth at a reasonable price” (GARP) approach. The Azzad Ethical Fund (ticker: ADJEX), which is categorized a growth stock fund, has been known to favor this style in certain market environments.

What do the metrics show me?

Once you’ve decided whether a fund’s objective and style make it a good potential candidate for your portfolio, it’s time to look at metrics that can help you determine how successful a fund is at achieving its goals, and what you might expect as an investor. Though past performance is no guarantee of future results, information on such metrics as returns, risks, volatility, and expenses can give you a basis for comparing one fund to another. Carefully consider not only a fund’s returns, but also how it achieved those returns.

When evaluating a mutual fund’s performance, make sure you’re comparing it to an appropriate benchmark, or to funds that have similar investment objectives and that invest in similar securities. For example, comparing a large-cap stock fund to one that invests exclusively in small-cap stocks won’t give an accurate picture of either one.

Performance is one of the most popular metrics used to evaluate an investments, and justifiably so. When looking at performance, however, consider both short-term returns for specific time periods–for example, a bear market–and longer time periods. Considering only short-term results can be misleading (for example, if a fund’s market segment, asset class, or investing style is temporarily out of favor). Also, be careful about what’s known as “chasing performance”–investing in funds solely because they have recently experienced high returns. Those high returns can sometimes (though not always) mean a market sector may be at a peak and about to rotate out of favor, as all sectors do periodically.

Equipped with this information, you’ll be better suited to make a better informed investment decision.

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