Shopping for Mutual Funds

Roll Up Your Sleeves and Log On

By Kara Stefan

A mutual fund is a convenient investment vehicle that allows a group of people to pool their money and buy a diversified portfolio of stocks. But with over 9,000 funds from which to choose, selecting a mutual fund can be quite a chore.

Evaluating a mutual fund involves scouring over the prospectus, checking out performance, management, and expense ratios–basically kicking the tires. It may not sound like much fun, but if you break down the process into manageable morsels, it’s not so overwhelming and can be quite educational.

The Convenience of Mutual Funds
Mutual funds exploded in popularity in the 1990s because they provided a way for the average individual to participate in the stock market without incurring excessive risk. Moreover, you don’t need a lot of money to get started. In fact, small contributions made each month are ideal.

“When you invest in a mutual fund, you become a shareholder in the fund and own the companies in the fund through fund shares,” explains certified financial planner Kay Shirley, author of The Baby Boomer Financial Wake-Up Call. “Therefore, you own fractional shares that represent multiple companies in the fund.”

What to Look For

• Performance:
  Obviously, most investors are interested in picking a fund with outstanding performance. But you have to be careful. There’s an interesting phenomenon that, each year, many top performers wind up at the bottom of the performance scale in subsequent years.

  Therefore, don’t be swayed by the best performing fund of the moment; instead, look for steady, long-term performance. Study a fund’s returns over at least the last 5 years–10 years or more if it’s been around that long.

• Management:
  Shirley makes an interesting point about money managers: “The average age for mutual fund managers is 29. If the market goes down 10%, will that person have the experience and knowledge to protect your assets?”

  Her message is clear: Look for managers with years and years of experience, people who’ve worked as analysts and in lower positions within the industry. No one wants to be a brain surgeon’s–or a money manager’s–first case.

• Load vs. No load:
  In investment lingo, a load is the sales commission you pay a broker to advise you on which mutual fund to buy. Essentially, he or she takes a percentage of the amount you invest. If you devote the time and effort to research which fund to buy, there’s little reason to pay a load. There’s no difference in terms of quality or performance between load versus no-load funds. So beware, some investment advisors will steer you toward a load fund merely to earn their commission.
• Expense:
  Mutual fund expenses comprise various combinations of sales loads, investment management fees, operations and administrative fees, and something called a 12B-1 fee that certain funds charge to help pay for marketing and distribution costs. Expense ratios–the tally for all the fund’s operating expenses–are expressed as a percentage of the assets under management and can range from 0.2% to 2%. Keep these guidelines in mind:
  • Compare historical performance to expense ratios–a high cost fund with good performance may present better value than a no-load with poor returns.
  • Avoid funds that charge 12B-1 fees.
  • Check management fees charged by various funds in the same asset class for an accurate comparison.
  • Be aware that global funds typically charge higher management fees due to the more extensive research required.
  • The Vanguard Mutual Fund Group is widely touted as one of the lowest cost fund groups on the market today.
• Turnover:
  The turnover ratio is a measure of how often a fund manager buys and sells individual securities within a one-year time frame. The average fund turnover is 100%, but some climb as high as 1000%. And every time a security is sold, the shareholders must pay the capital gains liability–an amount that can rapidly add up. So look for funds with low turnover, which tends to be a good indicator that the manager has confidence in his securities and plans to hold on to them for the long term.

Where to Look
The Internet–as it does for so many areas of interest–can tell you just about everything you need to know about mutual funds in general or any one mutual fund in particular.

Morningstar Inc. is known as the premier mutual fund research company, where you can log on and access much of the in-depth information free of charge. This site offers a comprehensive database with fund recommendations, comparisons, ranks, performance detail, quick stats, fund holdings, and “inside scoop” commentaries.

Morningstar is where the professionals start their fund analysis. If you’re serious about shopping for the right mutual fund for your situation, it’s worth checking out.