How do I compare two mutual funds with the exact same past returns?

You need to look at how much risk each fund manager took to get you that 17% return by checking their standard deviation and Sharpe ratio. Looking at past returns is like looking at the final destination of a journey without asking how bumpy the ride was.

Think of it like taking a bike trip to Ladakh. You have two route options to get there. Option A is a smooth and scenic highway.

Option B is a broken and accident-prone dirt road with extreme elevation changes. Both routes get you to Ladakh at the exact same time. But Option B is highly volatile and far less enjoyable.

In mutual fund terms, if a fund achieves high returns but takes on extreme volatility to get there, it is taking on excessive risk. This is where a metric called the Sharpe ratio comes in. It measures the extra reward you get for the extra risk the fund took compared to a safe government bond.

Imagine your two funds have nearly identical 3yr annualized returns of around 17%. But Fund A has a Sharpe ratio of 0.62 and Fund B has a Sharpe ratio of 0.73. The higher the Sharpe ratio, the better the fund manager is at handling volatility.

Fund B is the superior choice here because it managed its risk much better to achieve the exact same level of returns. You can also check the standard deviation. If a fund has a 3yr return of 17% and a standard deviation of 15%, you can expect the returns to fluctuate by plus or minus 15% going forward.

Always compare these metrics against direct peers. Compare your flexi-cap fund against other flexi-cap funds to see which one offers the smoothest ride to your financial goals.

Disclaimer: All information shared above are strictly for educational and informational purposes only. It should not be construed as financial or investment advice.