Mutual funds are one of the most popular investment vehicles on the market thanks to their diversification, which means your money is spread out among hundreds or thousands of companies. This protects your investments from any downturns in the market, which helps you build wealth. Instead of investing in individual stocks, mutual funds allow you to easily invest in the entire stock market — or just one sector — by investing in just one mutual fund. And with only a few mutual funds, you could build a well-diversified portfolio with multiple asset classes and a broad market exposure.
But you might be wondering, as you would for any other investment, what kind of return you can expect with mutual fund investing. Experts agree that investing is the key to building wealth, but just like any investment, there are risks. Mutual funds tend to outweigh most of the risks because of their diversification. We spoke with a couple of finance industry experts to learn what the average return is for mutual funds, as well as how those returns compare to other types of investments.
Average Returns for Mutual Funds
There are more than 7,500 mutual funds that span different sizes, investment styles, sectors, and more. As a result, it would be impossible to pin down a so-called “normal” or average return that would apply to every mutual fund. Instead, the return you can expect depends on the type of mutual fund you’re investing in.
“When people talk about ‘average returns’ they are normally referring to a certain benchmark like the S&P 500 Index,” said Ryan Ortega, a financial advisor and the founder of Third Line Financial Planning in Los Angeles.
According to the U.S. Securities and Exchange Commission, the stock market has an average historical return of about 10% per year. However, that only tells what type of return you might expect if you invested in a total market mutual fund.
When you add other types of mutual funds into the mix, the average return may look very different. After all, some mutual funds are made up of fixed-income assets with historically lower returns than the stock market. On the other hand, you might also have a mutual fund filled with small-cap stocks, which are known for greater volatility but higher growth potential.
Average returns also differ from active to passive funds. A passive fund — also known as an index fund — is one that tracks the performance of a particular index. An active fund, on the other hand, has a fund manager that actively manages it and chooses the investments. Historically, passive funds tend to outperform active ones consistently, especially over longer time horizons.
Ultimately, there’s no one average return we can apply to all mutual funds. Instead, it’s important to consider your required return — meaning the return you would need to achieve your financial goals — and the type of funds you’re invested in.
“One issue that we run into is we’ll read different articles and see different number quotes,” Ortega said. “We might see that the stock market has returned 8% over the years.”
But according to Ortega, it isn’t enough to simply compare that benchmark number to your portfolio and if your portfolio falls short, assume you’ve done something wrong.
“First, we have to understand the timeframe where that number is coming from. What start date are they using? Understand if that number is looking at stocks and bonds or only bonds. Then when you compare it to your portfolio, you can look at what assets your portfolio is holding compared to that benchmark.”
Average Returns by Sector
As we mentioned, one of the factors that influence mutual fund returns is the sector they’re invested in. Some mutual funds incorporate all 11 stock market sectors, while others may focus on just one.
Over any given timeframe, the returns of one sector can differ significantly from the returns of another. For example, according to data from the S&P Dow Jones Indices, in the 12 months preceding February 2022, the energy sector had the highest returns, with an annual average of 53.67%. On the other hand, the communications services sector had an average annual return of negative 3.64%.
Had you only invested in one of these sectors, your portfolio would have either performed really well or really poorly. However, we can never know ahead of time which sectors will perform well. As a result, financial experts generally recommend a diversified portfolio that includes exposure to all sectors so you can take advantage of large gains while somewhat insulating yourself from the effects of large losses.
If you’re just getting started with investing, consider opting for a target-date mutual fund or one that tracks the total stock market. You’ll have broad market exposure and a portfolio that keeps pace with the market, which can help you build wealth.
Mutual Fund Returns vs. Individual Stocks
Many investors choose to invest in individual stocks instead of mutual funds, but many experts disagree with this financial move. When we look at individual stocks, it becomes even more difficult to identify an average return. Just like the different sectors we discussed, some stocks will outperform the market, while others will drastically underperform.
One of the benefits of investing in mutual funds is you get many of the benefits of investing in individual stocks. But instead of buying just one or a few individual stocks, you’re buying hundreds or thousands. You get the benefit of those stocks that match or outperform the market. And at the same time, those stocks that underperform don’t make up enough of your portfolio to do any real damage. This is why diversification is so important.
It’s also important to note that mutual funds offer more exposure not only in the number of stocks in your portfolio but also in other assets. When you build your portfolio with individual stocks, you only have equity exposure, and as a result, are likely to see your portfolio take a major hit when the stock market is down.
But a more diversified mutual fund portfolio might also include bonds, commodities, and more. As a result, when the stock market is down, you might have investments that are performing better and can help to alleviate some of the volatility in your portfolio.
Mutual Fund Returns vs. ETFs
Mutual funds and exchange-traded funds (ETFs) are similar in that they are both pooled investments that hold a large number of underlying assets. They can either track the performance of a particular index or be managed by a professional fund manager.
The key difference between mutual funds and ETFs is the way they trade. An ETF trades in a similar way as a stock, while trades on a mutual fund work a bit differently.
“One significant difference between mutual funds and ETFs is that while mutual funds trade only once a day at the end of the day, ETFs trade throughout the day,” said Dann Ryan, a CFP and the founder of Sincerus Advisory. “So while this means you get one price a day on a mutual fund, you get many for an ETF.”
When you decide to invest in a particular index, you’ll often find both mutual funds and ETFs for that index. For example, there are S&P 500 mutual funds and ETFs, and they both hold the same underlying assets.
The biggest difference in your returns when you have a similar mutual fund and ETF is likely to come down to the fees. For example, Vanguard’s S&P 500 mutual fund has an expense ratio of 0.04%, while it’s S&P 500 ETF has an expense ratio of 0.03%. The difference between the two is so minimal you’ll barely notice it in your returns. But if you had expense ratios that were significantly further apart, the difference between your returns would also be larger.
Additionally, as we mentioned, both mutual funds and ETFs can be either active or passive, and each fund has its own strategy and prospectus. If you’re going to compare the returns of a mutual fund to those of an ETF, be sure you’re comparing funds with a similar asset allocation.
Mutual Fund Returns vs. Hedge Funds
A hedge fund is an investment vehicle used by wealthy individuals where they pool their money together to invest in higher-risk opportunities.
While the goal of a mutual fund is often to match the returns of the stock market, the goal of hedge funds is to beat it. However, in exchange for those higher potential rewards, investors must also accept above-average risk. As a result, hedge fund investments are generally only available to accredited investors, meaning those with high incomes or high net worths.
Just like individual stocks and sectors, investing in hedge funds offers little predictability. In any given year, you’ll likely have some hedge funds that drastically outperform the market and others that drastically underperform. And at the start of the year, you won’t know which is which.
When considering adding mutual funds or hedge funds to your portfolio, it’s likely not an either-or decision. Instead, experts generally recommend allocating the majority of your portfolio to diversified investments like mutual funds, while leaving just a small portion for speculative investments, which could include hedge funds or other types of investments like cryptocurrency.