How To Analyze Mutual Funds
Knowing how analyze mutual funds will allow you to enter a new realm of informed investors. If you've ever felt lost when choosing investment options, there are a few key points to remember that will help you pick historically consistent funds and avoid perennial losers. Here are five important steps to identifying and purchasing the right mutual fund for you.
- Order the fund prospectus. This document must give you information that is essential to understanding the investment goals of the fund, types of underlying securities, risks of investing, manager tenure and historical returns. Although a prospectus is always delivered when you purchase a fund, the Securities and Exchange Commission recommends you order and read the prospectus before buying a mutual fund.
- Understand mutual fund fees. Mutual funds are a business and the way they make money is by charging fund investors with loads, management expenses and 12b-1 fees. A load is the fee charged by a brokerage service as a commission to complete the sale of the fund. A front end load charges a fee as money deposited into the fund, a rear load charges funds as dollars exit the account, and a level load charges additional fees throughout the investor’s experience with the fund. Some funds sold directly to investors charge no load. Management expenses compensate the management team for oversight of the fund operations, and are calculated as a percentage of fund assets that are skimmed from the top on an ongoing basis, but are stated for investors as an annual percentage, such as 1 percent. Finally, 12b-1 fees are expenses related to sales and distribution of the fund and are also stated for the investor as an annual percentage, such as 0.25 percent. Fund expenses vary widely, so a good way to gain familiarity with fees is to compare many similar funds.
- Review historical performance. The prospectus details how well funds have performed. Financial expert Ric Edelman warns investors not to get caught up in short term returns because historically funds which performed well last year have trouble maintaining their superior returns. Instead, find funds which have performed well over longer periods, such as five or ten years. Financial guru Jean Chatzky likes to use financial websites to compare funds online. Many are available online at no cost.
- Check the manager’s tenure. If a fund has a great long term track record, but the manager is new this year, you may be purchasing another manager’s great investment approach. Make sure the management team currently at the fund is responsible for the past performance of the fund.
- Find the fund’s “turnover” and expected dividend rates. This tip is especially important for non-IRA investments where taxes will be due on fund capital gains and dividends each year. Turnover is shown as the percentage of the portfolio which changes each year, so a fund with 100 percent turnover trades out the entire portfolio each year. Why is this important? Because each trade may create a taxable event which is passed on to shareholders, funds with high turnover may create a large tax bill that you’ll be responsible for each April. Dividends will also be taxable in a non-IRA account, so it’s a good idea to have a handle on this before investing, too.
Chatzky, Jean Sherman & Arielle McGowen. (2010). "Money 911: Your Most Pressing Money Questions Answered, Your Money Emergencies Solved." New York, NY: Harper.
Edelman, Ric. (2005). "The Truth about Money." Emmaus, Pa.: Rodale.