by Rick Imhoff
for the Business Journal
Over the past 20 years, the mutual fund industry has expanded from 500 funds with $100 billion in assets, to more than 9,000 funds with $5 trillion in assets. They are popular investment vehicles for 401(k) plan investors and individual investors.
Because of the large number of funds available, it has become more difficult for investors to select the right ones for their investment portfolios. Here are a few tips to help you in the selection process:
1. Clearly define your investment objectives. Before purchasing any investment, you must first decide want you want to accomplish with your money. You need to identify the time frame required to accomplish your goal, your tax bracket, tolerance for risk (volatility), and other investment constraints.
By answering these questions first, you will eliminate several alternatives and narrow your choices down to a more manageable number. This step is typically skipped by most investors, which has resulted in frequent disappointment. Your expectation can be more closely met by first eliminating those funds that do not meet your objectives.
2. What are the costs? All mutual funds have charges and expenses to operate, manage and promote their funds. Some funds charge an up-front sales charge on the amount you invest, while others charge a back-end sales charge when you make withdrawals from the fund.
There are some funds that charge level lows, which means they spread the sales charge out over a few years. Some funds are called no-load funds because they do not impose a sales charge. However, all mutual funds, whether load or no-load, have to pay for money managers and the expenses to operate and promote the fund.
Just because a fund is no-load or has lower annual expenses does not necessarily mean it will perform better. However, the lower the expenses, the less overhead fund managers have to overcome in trying to earn the rate of return you expect on your investment.
3. Fund management. The longer the fund managers have been managing the assets of the fund, the better. This does not guarantee success, but at least you can see how well they have performed over a number of years and during different market conditions. You can also see how close they have stayed to their management style.
A fund manager's track record can be a deciding factor when the list of mutual fund options has been narrowed down to just a handful. If a fund manager has managed a particular fund for only a short time, he or she may have a track record with another fund with similar investment objectives that you could review.
4. Rating services. There are several publications that can provide detailed information about the funds you may be considering. Don't pay as much attention to the ratings these services assign to a fund as you do to the other data in their analysis. You can obtain a great deal of information from the analysis which can be used to compare other funds with similar investment styles.
5. Current holdings. Look at the top holdings of the fund. Does the list include companies you would invest in? Do they match the investment objective of the fund? Are they heavily weighted to one industry?
Depending on how often the fund manager turns over the portfolio of the fund, you will need to review the top holdings periodically to see if the fund manager's top choices continue to match the stated objective of the fund.
6. Performance. The first thing investors usually want to know is the past investment performance of a fund, but it should be the last thing to consider. If you truly want to achieve your investment objectives, within the level of risk you find acceptable, you need to look at all the other factors as mentioned above.
When you look at performance, you want to look at the longest possible period of time. Ideally, you want to see how the fund performed during both bull and bear markets. This won't guarantee the fund will perform similarly in the future, but you can get a feeling about the volatility of the fund.
By following these six tips, you won't guarantee your returns will always be the best, but you would have worked through a systematic approach of selecting a handful of mutual funds with which you can be comfortable. Periodically, you need to review your mutual fund selections to see if they still meet your investment objectives, and whether there have been changes with the fund or changes in your financial goals.
(Rick Imhoff, CFP, is a trust officer with Empire Bank in Springfield.)
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