Several months ago when I was just starting to blog, I was lucky enough to get the chance to have a large captive audience with my very first guest post on someone else’s personal finance blog. Patrick at Cash Money Life, one of my absolute favorite money blogs, loaned me his readers for the day last September. My article, The Top Eight Characteristics of a Great Mutual Fund, talked about the attributes you should specifically look for when finding a new mutual fund to invest in. The posting was even picked up by the newswire service, Reuters, and ran on their website.
In the original post, I talked about how to pick mutual funds by looking for the ones with great track records, low expenses, high morals, great fund managers, and a host of other factors. But, that was such a long time ago, millennia or so it seems in today’s fast changing economic conditions. So, I thought that it was long overdue for me to update the original guest post here on Own The Dollar and provide some new insights about a few new characteristics (and some old reliable ones too) you should look for in order to find an outstanding mutual fund in today’s challenging stock market.
We all know that we need to invest in mutual funds for our long term financial success whether your financial goals are retirement, college education for your children, a new home, or any other objective. And, even though we have seen one of the roughest stock market and economic slumps in our lifetimes, investing in stocks and stock mutual funds are the best ways to increase your wealth and save for the future. Despite the ups and downs of the market, there is no better vehicle for long-term growth than stocks and the mutual funds that invest in them. But, what should you look for in a good mutual fund? What makes one mutual fund better than another?
Fundamental attributes of quality mutual funds in a turbulent stock market
1. Risk Tolerance. Are they consistent? Do they have a written and proven investment strategy that does not change when the investing wind changes direction? Are they taking the correct amount of risk given their investing style? Knowing all of these attributes can help you pick the best mutual funds to invest in.
2. Low Expenses. A fund that buys and sells the stocks rapidly racks up brokerage commissions just like we do when we buy individual stocks. All of those $7 per trade commissions add up very quickly for us common stock investors. Just imagine the costs associated with selling millions of shares everyday. Low expenses mean that you keep more of the mutual funds profits in your pocket instead of paying salaries, commissions, administrative fees, etc.
3. Diversification. Mutual funds and their managers have a specific game plan when it comes to their investing style and strategy. They should always state what that plan is and stick to it. Be leery of funds that change styles or strategies with out a good reason. The fund you invest in should fit into your overall diversification strategy. If the fund manager changes his investment style, it could throw your own diversification off. Do you know which individual stocks the mutual funds invest in? Do you know their largest ten positions? Are several of your mutual funds investing in a lot of the same stocks? You could have a huge percentage of your portfolio accidently invested in a single stock than what is safe by not knowing what your mutual funds invest in.
4. No Loads. In the struggling economy that we have recently experienced, almost all mutual funds have decreased in value across the board. If you were paying a load on your mutual funds, a fee for the privilege to invest in a particular fund with a particular manager, you might have been paying a 4.5% fee when you invest for the privilege of losing your money. Now that really hurts! It cannot feel good to pay a fund manager’s loads just to watch your IRAs and/or 401-k decline in value. In most cases, you should stick to no load mutual funds.
5. Long Term Records. It is still important to look at mutual fund managers’ long term track record, but you should look back at returns and consistency over the long term. The current market is tanking many fund managers’ one, three, and five year rates of return. But, we should be looking back even longer to find the cream of the crop. This year’s abysmal returns have decimated most managers’ stellar track records. Stalwarts like Dodge and Cox Stock’s (DODGX) John Gunn who has been with the mutual fund since the 1970′s and has millions of his own dollars invested in the fund deserve to be looked at beyond past returns. So, how do you pick then, the one with the least sad record? Unlike modern baseball players, I am loyal to great mutual fund leaders like Gunn who had returned over 10% a year to investors before the crash over the past ten to twenty years. .
6. High ethical standards and reputation. After all the scandals that investors have had to endure in the past decade from the likes of Enron, Worldcom, Bernie Madoff, and many others, you must continue to demand high ethical standards in every company you do business with. Ethical standards are more important than ever. The Ponzi Scheme perpetrated by Madoff shows that we must be diligent in monitoring our investments and that proper diversification is the only way to ensure that our nest eggs will not be totally decimated by a fraudulent person or company.
7. Fund Assets Too Big. When a mutual fund manager does well, he or she can be guaranteed to receive more assets to invest. But, having more assets is not always a good thing. It can be hard for a large, cumbersome mutual fund to maintain its asset allocation. Also, when a mutual fund does well, it usually receives a lot of press and more investors flock to the fund. But, the company got the accolades because they have done well. What good does it do you to pile in after all the other investors who beat you there already made their profits? There is the possibility of buying shares of the fund at a high price which goes against the fundamental investing tenet of “buying low and selling high”. Plus, when a mutual fund’s assets are too large, it can be cumbersome for the fund manager to buy shares, maintain diversification, and enter markets efficiently without raising prices and the costs of doing business.
8. A member of Money Magazine’s Top 70 or Kiplinger’s Top 25 Mutual Funds. These two magazines update their lists of the best mutual funds every year based on their strict search criteria. If you purchase shares in one of the mutual funds they recommend, you can be assured that it has been vetted and screened to be one of the best. Like with all investments, there are no guarantees of course, but these lists make a great starting point or second check after you have completed your own research.
There are over 21,000 mutual funds to choose from, and it can be a daunting challenge to find the one that is best for your investing situation and financial goals. But, choosing the perfect mutual fund for your portfolio can be done with a little research and can make the difference between peace of mind or pulling your hair out looking for that diamond mutual fund in the rough.