What to Look For in a Mutual Fund
By: Source: AARP.org Date Posted: 2005-03-20 12:09:10
It's tempting to pick a mutual fund based on the five-star rating it received from a mutual fund rating service. These ratings should be respected, but they tell only part of the mutual fund's story. Ratings represent an assessment of a mutual fund's past performance. They do not guarantee future performance. In addition to a good rating, make sure your fund has certain characteristics, including those listed below.
What You Should Know
Look for these traits in your mutual fund:
A Manager with a Good Track Record
When you choose a mutual fund, you're really choosing the manager who decides where the fund will invest, when it will buy securities, and when it will sell them.
Look for information about your fund's manager in an investment guide or in the fund's prospectus. Assess how the fund has performed under the manager's guidance. If the manager is new to the fund, find out where he or she worked before and how that fund performed, compared to the performance of other mutual funds.
An Objective that Meets your Needs
Identify one or two mutual fund objectives that seem to fit your short-term and long-term financial goals. Make sure the fund you choose has one of these objectives. A fund's objective is identified in its prospectus, in investment guides, and in the financial pages of some newspapers. Selecting a fund with the appropriate objective will give you an idea of how volatile the fund will be.
A Risk Level that Suits You
It's important for investors to be comfortable with the risk associated with their investments. Look in the fund's prospectus or in an investor guide to find a year-by-year listing of your fund's returns. Scan each year, looking for the fund's worst year. If you owned shares in the fund that year, would you have sold them? Developed ulcers? If the answer to either question is yes, then the fund may be too risky for you.
Good Performance
How much did investors in the mutual fund make last year? Over the past five years? Ten years? The answer to these questions can be found by looking at the total return, which measures gains (or losses) in the value of mutual fund shares over time. The higher the number, the better the return.
Compare your fund's returns to the returns of other funds like it. You can find this information in the fund's prospectus, or you can compare your fund's return to an appropriate index. If your fund is down and the index is up, your fund may not be as good as you thought.
Many investors are careful not to base their selection of a mutual fund only on good performance. For one thing, no manager can continuously outperform a fair benchmark, like an index. Even good mutual funds will falter from time to time. In addition, investors who buy shares in a successful mutual fund always run the risk of buying shares at a high price just before the fund begins a period of underperformance. Consider performance when selecting a mutual fund, but don't make it your only criteria.
Affordability
Find out what fees the fund charges and whether it requires a minimum investment. Can you afford these?
User Friendliness
Decide how comfortable you feel when you interact with the mutual fund. Are the fund's written materials easy to understand? When you call on the telephone, is the staff person friendly and knowledgeable? The telephone will be your main means of communication with your mutual fund. Make sure you feel comfortable with the people to whom you have entrusted your savings.
For More Information
The Alliance for Investor Education
You can test your knowledge about mutual funds on a Web site run by the Alliance for Investor Education. The site also features a mutual fund fee calculator and a "Guide to Understanding Mutual Funds."
URL: http://www.investoreducation.org
The Securities and Exchange Commission (SEC)
The SEC Web site offers a variety of useful information for investors. Under "Investor Education," look for online publications about mutual funds and Interactive Tools, including a Mutual Fund Cost Calculator that will help you compare the true dollar cost of mutual funds. Use the EDGAR Database (listed under "SEC Filings and Forms") to find and read a mutual fund's prospectus.
URL: http://www.sec.gov
The Investment Company Institute (ICI)
ICI is a trade organization for the mutual fund industry. The group publishes a host of information about mutual funds, including "Frequently Asked Questions About Mutual Fund Fees."
URL: http://www.ici.org/funds/abt/index.html
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