This article is by staff writer Robert Brokamp.

I’m a bit of a nut about Christmas; I even have a daughter named Noelle. So this time of year can be a bit of downer for me. The tree gets disassembled, the Bing Crosby CDs get packed away, and the holiday cards stop coming. Regarding that last one, however, the void in my mailbox will soon be filled by a different type of tiding — in the form of annual statements from my investment accounts.

OK, so they’re not as jolly as cards with pictures of friends and relatives. But using your year-end statements to give your portfolio a thorough checkup can pay off, especially if you discover ways to increase your chances at higher returns. To see the potential benefit, check out this table, which shows how much $10,000 could amount to, given different rates of return and time periods. As you can see, earning another two percentage points a year can add thousands of dollars to your net worth.

Annual Return 5 years 10 years 15 years 20 years
6% $13,382 $17,908 $23,966 $32,071
8% $14,693 $21,589 $31,722 $46,696
10% $16,105 $25,937 $41,772 $67,275

Alas, you can’t just snap your fingers and pump up your returns. Most investments involve taking on risk, which many people think of as volatility — the ups and downs you’ll experience — but I prefer to think of it as uncertainty, as in you generally don’t know exactly how an investment will perform, which can make things like retirement planning a bit of a challenge.

Still, there is a way to increase your chances of earning higher returns: Replace your lagging mutual funds. It is not guaranteed to juice your returns, but the evidence suggests that there are some common characteristics of funds that tend to outperform most others with similar investment objectives.

So as you review your year-end statements, keep these suggestions in mind:

1. Consider replacing actively managed funds with index funds

As I recently wrote, approximately 70 percent of actively managed funds (those who pay actual people to pick the investments) underperform comparable index funds (which just copy a market barometer such as the S&P 500). In 2014, the failure rate was even higher, making last year one of the best for index funds in decades.

2. Focus on costs

The evidence is clear: Lower-cost funds tend to outperform higher-cost funds. In 2010, Morningstar analyzed how much expense ratios and the company’s proprietary five-star fund rating system predicted a fund’s ability to outperform its peers. The conclusion: “If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds…. Investors should make expense ratios a primary test in fund selection. They are still the most dependable predictor of performance.” This explains a good deal of the secret sauce of index funds — the average actively managed fund has an expense ratio 10 to 15 times higher than that of a comparable index fund.

3. Compare apples to apples

If you just listened to the headlines, you would think that 2014 was a great year for investors. After all, the S&P 500 and the Dow Jones Industrial Average reached all-time highs. However, those indexes focus mostly on large companies in the U.S. – Apple, General Electric, Johnson & Johnson, and so on. Such types of investments outperformed most others last year. So if you compare, for example, a smaller-company fund to the S&P 500 or Dow, the fund will likely look like a laggard. But that doesn’t mean you should get rid of the fund. In fact, historically, small-cap stocks have outperformed large-cap stocks over the long term; it just doesn’t happen each and every year. So you should instead compare the fund to other small-cap funds to see if it’s worth keeping.

4. Compare apples to pommes — that’s French for “apples” — carefully

Last year, the U.S. stock market outperformed the markets of all other developed countries, which collectively were down 3.9 percent, compared to the S&P 500′s gain of 13.7 percent. Standard & Poor’s tracks the performance of 48 global stock markets, and 30 of them were down in 2014.

Thus, the more money you had in an international stock fund last year, the more likely that your portfolio didn’t match the S&P 500 — even if it is a good fund. Consider the performance of Dodge & Cox International, which was essentially flat last year. If you anchored on the S&P 500′s double-digit return, you might conclude that the Dodge & Cox fund stinks. But its whopping 0.1 percent return actually placed it in the top 9 percent of large-company foreign funds in 2014, according to Morningstar. Since most other international funds lost money, making a teeny-tiny profit was exceptional.

You may be wondering, “Does this mean I shouldn’t invest in international stocks?” Nope, at least not in my opinion. There will be times when non-U.S. stocks triumph, such as most of the first decade of the 2000s. It would be grand if we could predict which investments will perform the best from year to year, but history shows that it is impossible. The solution for most people is to have a very diversified portfolio — which includes stocks of all sizes from around the world — so that when one investment is down, another is up, or at least not down as much. However, the “down” part is part of the deal. One of my favorite quotes comes from Pittsburgh-based financial advisor Louis Stanosolovich: “If you’re not losing money somewhere in your portfolio, you’re not diversified enough.”

The nuts and bolts of comparing those apples

The best place to analyze your funds is Morningstar.com, which ranks a fund’s performance relative to other funds with a similar investment objective. Enter the fund’s five-letter ticker in the “Quote” field at the top of the site, then click on “Performance” and scroll down to the “Rank in Category” row in the “Trailing Total Returns” box. The lower the number, the better. For example, a 6 would indicate that the fund’s performance ranks among the top 6 percent of funds that invest in similar types of assets.

As you size up your funds, keep these in mind:

  1. Look beyond the one-year return to the five-year return or longer.
  2. Just because a fund finished in the top half or even top quarter of other funds doesn’t necessarily mean it beat a comparable index fund.
  3. A significant chunk of top-performing funds in one period doesn’t duplicate their top-ness during the subsequent period. But performance is still worth considering if you are looking to replace a high-cost, low-performing dud, especially if a low-cost index fund isn’t available as is often the case in employer-sponsored plans such as 401(k)s.
  4. While taxes should rarely be the primarily reason for holding on to a bad investment, you should still be aware of the consequences if you are selling a fund in a taxable account.

Best of luck, and here’s to better-faring funds in 2015!

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