I started a community project where I asked a bunch of personal finance bloggers for their tips on a given topic. The response has been wonderful thus far. It’s really helping me (and thus, you) find the best financial advice out there.
I’m currently in the process of rebalancing my investments. What are things you should look for when evaluating a mutual fund that you want to buy? Here are a few essentials you should look for. Here is the knowledge from the collective.
Past performance relative to its peers.
All mutual funds fall under some classification. The question is: Did the fund do well compared to other funds that invest in similar things? Example: Of all mutual fund that concentrated on the energy sector, which of them performed the best year after year?
Cost.
Fees can eat up you interest. For example, if the fund returns 12% in interest and there are 4% in fees, then your in-your-pocket return is actually 8%. Doh. What kind of fees can there be? This can include the following: Front-end load, Purchase fee, Back-end load, Redemption fee, Exchange fee, Account fee, Management fee, 12b-1 fee, and expense ratio.
The fund manager’s past success and reputation.
You want to weed out the one-hit wonders. Any mutual fund manager can get lucky. A blind squirrel finds a nut once in a while. It’s rare to find a manager who can consistently perform. This is the mutual fund manager you’re looking for. Note: Be aware if your mutual fund manager leaves the fund you’ve bought. Sell your fund if you don’t like your manager’s replacement.
Fund style.
You want to look at what the fund concentrates on. This is the style of the fund. This will help you determine your asset allocations when balancing your portfolio. It will also help you determine the risk/return factor. For example, energy funds tend to be more volatile whereas money market funds tend to be less volatile.
Is it an index fund?
Here’s some math: Index fund = Less internal trading. Less trades = Less taxes. Less trades = Less management fees. Index fund = More diversity within their asset class.
Style purity.
Does the fund consistently do what it promotes itself as doing? Example: Does a small cap fund keep its small cap focus even when small caps are out of favor. A lot of managers tend to lean toward what looks good at the moment. Sometimes they forget what their fund’s focus is.
How much is the fund manager invested in his/her own fund?
It is important to gauge how much the fund manager has invested in his own picks. If a fund manager hasn’t invested a good chunk of his own money into the fund, it could indicate that the fund manager is less sure of his fund’s investments.
Minimum initial investment.
For most people, there’s a big difference between a minimum investment of $1,000 and a minimum of $25,000. You want to make sure that you can handle the minumum before you buy a fund. I’m sure you’ll quickly find out the minimum before you buy it. Another thing to look at is the subsequent contribution minimum. I have one that can only do increments of $500. Grrrr.
The fund’s asset turnover.
Asset turnover measures a firm’s efficiency at using its assets in generating sales or revenue - the higher the number the better. Especially if you’re holding a fund in a taxable account and are concerned about tax consequences.
[I understood it wrong. Here’s the rehash from Ricemutt of Experiments In Finance (Thanks for the correction!)]:
High asset turnover isn’t necessarily (or usually) a good thing when it comes to mutual funds. If it’s a passive index fund, then turnover should definitely be low.
Turnover might be high if the fund is an actively managed fund, but it also means that it will probably create large distributions to your account, which are taxable (and inefficient) if you hold the fund in a taxable account (versus an IRA, etc.) It just depends on what you’re looking for.
Thanks to everyone who contributed their financial knowledge to this hive. I hope everyone who reads this knows what to look for when evaluating a mutual fund.
Rock and roll.
[Photo Credit: aiesecnz ]