7/17/2014 11:45 AM ET|
6 tips for picking the right mutual fund
A 4- or 5-star rating is great, but it pays to dig a little deeper when you're researching funds for your retirement portfolio.
When it comes to making investment decisions and preparing for retirement, many investors fall prey to snap judgments based on a mutual fund's star rating or simply become overwhelmed by information overload. The good news is that there is a middle ground that can help you navigate your options and make informed decisions.
The following six considerations -- all of which can be easily found on a Morningstar fund report -- can help you assess your investment options.
1. Read up on your funds' portfolio managers
The captain of a ship controls the fate of passengers just as a portfolio manager of a mutual fund is in control of the individual investor's financial journey. Therefore, it is important to review the manager's tenure and the performance of the fund since they've been the "captain" of the portfolio. If performance has steadily improved or declined over the course of their tenure, that may tell you something important.
With a bit of digging, you'll find details on a fund manager's experiences and background that can be telling. If the manager has overseen the fund for less than two years, I like to look into their prior experience managing money in the same investment category (for example, large cap, small cap, bonds, real estate investment trusts) as well as past investment performance. If they were successful in a similar category, it should give you confidence that they have the experience necessary to "steer the ship" on the fund they currently manage.
2. Understand the asset allocation of your investments
You should understand your portfolio's asset allocation (stocks, bonds or cash) for each fund in your portfolio. In both good and bad market conditions, portfolios can drift into more aggressive allocations than previously established when you first began investing. The key is to have a mix of stocks, bonds and cash within a portfolio that matches your risk tolerance, financial goals and time horizon.
3. Look at a fund's top holdings
The top holdings can be a great barometer for how the fund will perform in different market scenarios, helping you form realistic expectations. For example, you may notice that a particular fund has several technology stocks within its top 10 holdings. In a market where technology shares are rallying, your fund is allocated to perform well. Unfortunately, it can also have the opposite effect. If tech stocks trade in the red, even on an up day for the overall market, you could see your holdings in the fund perform flat-to-down for that session.
4. Dig into new holdings and largest position changes
Exploring a fund's new holdings and largest position changes will illuminate the number of shares that have been added or subtracted since they were last reported (typically every three to four months). Based on that information, you'll better understand how the fund manager is investing new cash into the fund. Finally, you might even want to put a few of these companies on your personal "watch list" to follow in the event you decide to buy individual stocks as well.
5. Assess your portfolio's expenses in relation to its returns
All too often, investors will look at total return and not understand the relationship of the fund's fee to that return. For example, you may have a fund with above-average expenses that is delivering strong returns, while a low-cost fund may be underperforming. Also make sure to review specific fund information to determine how the fee level of each fund stacks up against its peer group.
This will ensure that you are not overpaying for below-average performance, as there is a balance to consider between expense and results. The lowest-cost funds are by no means the best performers just as the most-expensive funds are not necessarily the worst performers. It's about results that translate to growth within the parameters of your goals and time horizon. Also remember that it's about overall value for your entire portfolio, not only for a single fund.
6. Know the turnover ratio on a fund
This ratio is important as it allows you to see how often the portfolio manager changes holdings within the fund. A high turnover ratio is not necessarily a bad thing, as some managers do trade more than their peers and market conditions may dictate more trading at times. There are near-term potential downsides of high turnover ratios: They may increase the likelihood of potential capital gains distributions, and frequent trading adds costs that can eat into returns.
Most managers are focused less on investing for tax efficiency, and more on maximizing the fund's total return. Although it might be disappointing to pay taxes on capital gains outside of your tax-deferred accounts (individual retirement account, 401k, etc.), having more money is a nice problem for any investor. That said, if capital gains are a significant sore point for you, explore funds that focus specifically on tax efficiency. They are out there.
It may be tempting to judge an investment opportunity by its Morningstar rating alone for simplicity's sake, but there are other key indicators of a fund's potential success that can help lead you to a more secure retirement. By keeping these six ideas in mind, you can better dissect your investments, looking inside the numbers and beyond the star rating.
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Yes, you could do a lot of research on items (which change constantly) and are highly subjective as to their impact OR you could invest in a few good index funds and consistently beat 2/3 of the managed funds. Also if you pick a winner, it probably (statistically) wouldn't be a winner in the next time period.
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