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How to select a mutual fund

Mutual funds are an important investment vehicle for many investors. They are professionally managed and offer diversification even for the small account.

Expanded Definition

  1. Select an allocation appropriate for your investment goals and risk tolerance. That will often include a mix of several categories of equity funds, bond funds, and possibly others.
  2. Consider the mutual funds available to you in your 401(k) plan or other similar qualified investment plans. Look them up on Morningstar.com [1] or in the information provided with your plan to determine first if the fund type fits your allocation plan.
  3. If your funds will be in a taxable account or in IRAs or Roth IRAs that allows a broad selection of funds, Morningstar is again a good place to review what is available. Your account custodian may have lower fees for certain funds. They can be important to consider.
  4. Review the available funds by the Morningstar star system as described in the Morningstar item.
  5. Select half a dozen funds from your available list by your preferred criteria, especially by performance and costs. Consider their numbers in detail. If its a sector fund, what are the prospects for this sector in the next year? See if one stand out better than the others. Have there been recent changes in fund manager? Is performance consistent year after year?
  6. Certain fund families are more attractive than others. Some are large and well known, and offer lower fees and better service to larger accounts. Try to limit your accounts to a handful of fund families to maximize your benefits consistent with good performing funds and low costs. Look out for little known funds with good numbers. Are they reliable?
  7. Before you write the check, read the fund prospectus. Are there any surprises? Many funds offer features like check writing, or electronic funds transfers to and from your bank. Are these appropriate for you?
  8. Do you want to reinvest interest, dividends, distributions? Or do you want to receive a check? Or transfer payments to the money market in your brokerage account?

Questions to ask

Some of the items of concern when researching mutual funds are:

Or, put another way:

  • Keep your expenses low!
  • Minimize your tax burden! (low turn-over)
  • Maximize the amount of money in the market!

If any of the above expenses or ratios are high, your returns may not be as high as you expect! Index funds are attractive because all of those ratios and expenses are extremely low.

Things to look for in a non-index based fund (i.e., a managed fund):

  • Low management fees (below 0.75%)
  • No sales charges (also known as loads or commissions)
  • No 12b-1 fees
  • Turnover no higher than 40% a year
  • Established track record
  • Consistent and strong management
  • Consistent returns

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