How To Choose A Mutual Fund

Knowing how to choose a mutual fund may seem overwhelming with the thousands of choice available, but it doesn’t have to be. Learn how to research mutual funds properly so that you can invest safely in a mutual fund that is right for you. Research will help you not only avoid high risk mutual funds but those with high fees as well.  Using a discount broker, determining whether you will buy an Index or managed funds, and accessing the funds Prospectus are the keys to choosing a mutual fund.

1. Use a discount broker. A discount broker sells mutual funds at a lower price.  You can purchase a mutual fund directly from a fund family or an online brokerage company. Use your favorite search engine and generate options for many discount brokers. The money you save purchasing a fund this way, will be well worth it.
2. Determine Risk Level. Choosing a mutual fund based on risk tolerance is important. Most online brokers provide risk assessment tools to determine the adequate level of risk. In addition, mutual funds have a scale from low to high risk. The beta determines the funds volatility. A beta of 1.0 is average risk, while anything higher rated is more aggressive. The amount of time before you retire also has an affect on the risk level. If you have five years or less, it is best to stick with less riskier investments, however, if you have five years or more, you will probably be better off with a more aggressive fund that offers higher rewards.
3. Diversify. Make sure that your primary fund is broad enough to cover the entire stock market. Meaning don’t buy a fund that specializes in pharmaceuticals if this is your first fund. Buy something that says  Large Cap Value or Large Cap Growth. Large Cap simply means the largest companies. Value means cheap and Growth usually means aggressive. Balanced funds are great if you want instant diversification. These funds are a combination of stocks and bonds. Buy these diversified investments and you will sleep at night.
4. Select an Index or managed fund. Choosing a Mutual fund requires selecting between an index or managed fund. An index fund invests in an entire segment of an industry or market, but does not have a manager. It is a like a mutual fund that is on auto-pilot. These funds are usually the best investments because they offer the widest diversification and the lowest fees as well. The index funds are easy to spot because they will all have the word index in their title and will have razor thin expense ratios. An expense ratio of .20% is not uncommon. A managed fund might have shares A listed in it is title. This type of mutual fund requires an up front commission in addition to the expense ratio.  Loaded mutual funds fall into this category. Here the fund’s manager receives at least a 5% fee immediately as well as the expense ratio. These higher fees substantially lower your gains. So stay away from them. Index funds will keep more money in your pocket.
5. Obtain the Prospectus. Once you have narrowed down your selection, obtain a Prospectus. A Prospectus outlines all of the details of the mutual fund.  The fund Manager’s tenure with the fund determines the stability of the fund. The longer he is there the more stable the fund is. A Manager with a long tenure shows stability in the fund. It also outlines the expenses associated with the mutual fund along with the actual holdings.

As you can see, choosing a mutual fund involves critical steps. Following these steps won’t make you the next Warren Buffet, but it will give you tools necessary to choose the right mutual fund and control your financial future.       

Resource:

Kansas, D. The Wall Street Journal complete money and investing guidebook. Three Rivers Press, 2003.