Evaluating a Mutual Fund

[zetta]

I've been reading a few books on investing, but still find I am frozen with uncertainty when I try to actually look at a particular mutual fund and decide whether to invest in it or not. I'm an engineer and good at math, but for this business stuff I just can't seem to get my head around which numbers I should be looking at and why.

To the regular investors here -- can you describe for me how you go about sorting through the thousands of funds out there, and then what numbers specifically you look at to choose a fund? Are there rules-of-thumb you go by such as "10-year return greater than X" or "load less than Y"? Is there non-numeric information I should be considering as well?

[rooskers]

First question is how long to you plan on holding the mutual fund? Second are you just going to put one large lump sum in or are you planning on making regular contributions to it each month? Lastly what type of risk are you willing to take?

[kv968]

Unfortunately there's no one real "magic number" you can look at when evaluating mutual funds. 5 - 10 year returns are good to look at to see how the fund handled different market scenarios. Mangement tenure would be something to consider too. Expense ratios are something to keep in mind also since extravagant fees or costs will eat away at your investment.

I would say the most important thing to consider when choosing a fund is, how does it fit into what it is you want and what it's intended for? Is it for retirement in an IRA or just a taxable holding? Do you want a "high risk/high reward" fund? Go with a small-cap, single sector, or possibly an int'l fund. Do you want lower risk/lower reward"? Go with a balanced fund or a large-cap domestic fund. Also how does it fit into your overall allocation of funds? Are you overweight in a class or size compared to another?

One thing I use to evaluate a specific fund is how it performed against it's benchmark and similar funds in it's category. Has it beat, followed, or severely lagged over a sufficient amount of time? You have to be careful with this however since funds can be (and frequently are) compared to a benchmark that has nothing to do with what the fund is comprised of. For example, you may see that an int'l fund has trumped the S&P 500 index for the past 4 years. That basically means nothing since the S&P 500 doesn't include any int'l stocks.

[disneysteve]

To the regular investors here -- can you describe for me how you go about sorting through the thousands of funds out there, and then what numbers specifically you look at to choose a fund? Are there rules-of-thumb you go by such as "10-year return greater than X" or "load less than Y"?

Regular investor here.

I generally have used the Money magazine annual mutual fund issue charts. I look at the funds in the category I'm interested in and pick the one with the best long-term track record and lowest expense ratio. As for "load less than Y", the load should be ZERO. There is no reason to invest in load funds at all, ever.

[meaghanchan]

I might be the only one here, but I don't consider past performance at all. What I am concerned about is if a fund meets my needs for my asset allocation, if it has low expenses (and no load) and if it tracks its benchmark.

[safari]

I might be the only one here, but I don't consider past performance at all. What I am concerned about is if a fund meets my needs for my asset allocation, if it has low expenses (and no load) and if it tracks its benchmark.

I think past performance is important, even though it doesn't guarantee future returns. If an actively manged fund consistently beat its benchmark over the years, then there is a good a chance that it will continue to do so. If your main concerns are the low expense ratio and tracking a benchmark, then it makes sense to invest in an index fund instead of an actively managed fund.

[Vapors]

I agree with Disneysteve, never pay loads. You should try also never pay high expense ratios. My wife's retirement fund is managed by Merrill Lynch and the guy is always recommending funds with total expenses of 1.8% to 2.5%, yet those funds never seem to return any higher then funds I pick with expenses less than 1%.

Also make sure you diversify. Don't buy just 1 or 2 funds. And don't buy several funds that are in the same category and think you are diversified. When you look at a fund you will see a boxchart with 9 boxes. I invest in all 9 boxes, but 50% is in large cap. The top left box is the least amount of principle risk and bottom right is the highest risk (but that bottom right has had 4 or so years of great returns).

I definitely look at past peformance too. It doesn't guarentee future success, but it's better then buying a fund that lags it's benchmark.

[disneysteve]

I don't consider past performance at all. What I am concerned about is ... if it tracks its benchmark.

Can you explain what you mean by that? You want to know if it tracks it's benchmark so don't you need to look at past performance to know that?

[jIM_Ohio]

smart money magazine might help. Also check out fundalarm web site. I am becoming a HUGE fan of fundalarm these days (getting real good and different ideas from that community).

Here's my take.

Have a vague asset allocation (% equity-%bonds-% cash%). If you cannot decide, I'd go 60-40 until you learn more. 60-40 is conservative growth. Around 6% annual expected returns.

Then choose funds. First, I would go 100% no load. Anything requiring 5% up front can save you the 5% by asking the questions you are already asking, and reading the books you are already reading.

Be willing to make mistakes (doing something is better than nothing). I admit I invested in Strong Blue Chip many many years ago. Not best fund, and I have done so much better since.

I would screen for funds:
a) large cap (value, blend and growth in same screen).
b) expense ratio below 1% and possibly below .8% or .6%.
c) open to new investors

Then look at funds and look for minimums. Vanguard (I hear) has a 10k minimum. Some Fidelity funds have a high minimum too. T Rowe waives minimum if you sign up for Asset builder ($50/month). Because T Rowe caters to small accounts there management fees are slightly higher (but still low). Higher relative to Vanguard, lower relative to most other fund houses.

Look at fund family. Compare offerings of Dodge and Cox to T Rowe Price to Fidelity to Vanguard to any other company which enters the screen. Then ask about that fund family on fund alarm... someone out there owns the fund and can share with you detailed customer experiences.

Fund alarm has turned me on to Manning & Napier (open small cap fund with small asset base), Hennessey funds (aggressive small and mid cap funds), Alpine Dynamic Dividend (aggressive income fund) and PRPFX (precious metals/commodities in a balanced fund). I am not changing what I do, but adding some diversification I would not otherwise have next year.

For example, small cap funds do not usually stay open for long if they are good, so finding good ones before they close takes research. T Rowe, Fidelity and others have good, broad small cap funds... but more aggressive small cap funds do exist.

[humandraydel]

This is probably not the answer you want, but I'm a low cost indexer at heart. So I tend to decide the AA I want and then buy (vanguard) index funds to accomplish that AA. I do have a few actively managed funds in my 401k but that's because there are no value indexes available in my 401k, so I have to use actively managed value funds to get the Growth-Value split that I want.

[jukebox9988]

I would start out with a Mutual Fund screener that organizes all my selected criteria by importance. You want to identify positive signals about the fund like:

-solid fund management
-low expense ratio
-Low to medium turnover
-Moderate standard deviation depending on your risk tolerance
- and of course, fund objective

I often spend hours just looking through fund screens to find hidden gems. Picking good funds is a long and enduring process because once you buy in, it's a good idea to stay committed for at least 6 months to avoid 12-b fees and extra taxes.

But you're doing the right thing by asking questions. If all else fails, try a target fund that matches your time horizon.

Good luck!