Analyzing Mutual Funds (Part 2)

Compare Mutual Funds - The best way to judge a mutual fund is to compare it to its peers. Select the funds in the sectors you desire from the families you've chosen and compare them to each other. You can get fund information from prospectuses (available online at the fund families sites) or through screening tools like Yahoo Finance or E*Trade. Look closely at the following aspects of each fund:

Management - Look at the background of the portfolio managers. Do they have a lot of experience? Do they have experience in the industry that they are analyzing? How is their past performance? How is their past performance on other funds and at other companies? Look for backgrounds that have business experience as well as finance experience, and look for someone with a solid track record and that thinks independently of investment bankers and institutional research analysts.

Investment Strategy - What type of strategy does the fund follow? This is clearly stated in the prospectus and is easy to find online. Do you want someone that speculates? Uses leverage? Holds too much cash? Tries to time the market? You'll find that strategies vary dramatically from fund to fund, even in the same sectors. For example, one growth fund may look for stocks growing 5% or more, while another looks for stocks that grow 15% or more. One growth fund may invest mostly in international, large cap stocks and another similar looking fund may invest in domestic small cap stocks.

Look closely at how the fund describes it's goals. Make sure that they match the type of fund you are looking for.

Fund Size - Look at the total size of the funds' assets. If it is small (in the $100s of millions) then the company may be able to get in and out of stock positions quickly. For larger funds (in the $billions), it is much more difficult to get in and out of stock positions. In fact, the largest mutual funds often have trouble finding enough stock to make their positions, which often leaves them no option to invest in some of the smaller cap companies. With that said, this is just one more tool to use when evaluating different funds.

Turnover - Do you want a mutual fund that is constantly buying and selling stocks or do you want an investment that buys and holds its stocks for a long period of time? Many funds say that they are long term investors but still have high turnover rates. Check the prospectus or information site you are using to compare turnovers. High turnover means higher commissions and expenses.

Holdings - This is one of the best ways to see what types of stocks your fund buys. Each fund is required to report its top 10 holdings each quarter, along with the percent held of each. Look at the list of top stocks. Are they too concentrated? Not concentrated enough? Are they all in the same sector? Are they chasing currently popular stocks? Are they international, domestic, large cap, etc? Compare the top holdings of each similar fund you are contemplating. Make sure that the same stocks aren't in each of the funds. For example, a stock like Microsoft could be found in growth, value, large cap, technology and many index tracking funds. Overall, the top holdings should give you one of the best answers as to whether or not you want to buy it.

Past Performance - This information can be found in any prospectus, charting service (like BigCharts.com) or mutual fund screening tool (like Yahoo or E*Trade). Look at the past performance compared to it's benchmark and compared to other funds you are looking at. If the performance is much better or worse than its peers, figure out why. And remember, past performance is not an indicator of future performance. There are many reasons why a fund has performed better or worse than its peers. For example, many funds that have done well over the past have often been invested heavily in certain sectors that have done well. Although these funds have performed well, they may have also taken more risk and could be currently exposed to downside risk if that sector goes through a down cycle.

With that said, past performance shouldn't be used as the main reason to select a mutual fund. However, by studying the past performance, you should be able to gauge what kind of returns are likely in the future. For example, two growth funds that appear identical could have vastly different returns over time. One might vary between -10% and 15% returns per year while another varies between -25% and 30% returns. Difference like this are probably a good indicator of the type of inherent risk and return that you can expect from those funds.

Fees - Once you've narrowed the funds you like down to a short list, start comparing the fees. Look at the load and the management fees. We recommend that you never buy any fund with a load (a load is a fee charged to buy the fund that is in addition to an annual management fee), unless you really, really like the fund. Loads are typically used to pay salespeople and financial advisors and you shouldn't have to pay these if you are buying on your own account. Regarding management fees, they vary from about 0.5% to upwards of 5%. We recommend that you find a fund that charges 1.5% or less. Remember, the management fee comes out of the fund each year, so if the total return on the fund is 8% and the fee is 3%, they've taken away 38% of your profit!!!

Minimum Investment - Finally, look at the minimum investments for a fund. Some minimum investments are $10,000 or more, so before you decide on a fund, make sure that you can meet the minimum investment criteria. For IRAs, this amount is often lowered so if you really want a high minimum fund, you could invest in it through an IRA.


-- ABC Stock Investment --