With over 8,000 mutual funds to choose from, picking a few to put your money into can be a bit overwhelming. If you have a 401k, the human resource department dwindled the list down a bit, if your lucky. But which to choose?
Well lets say you’ve decided on the type of a fund, a growth fund for example, but you still see that you have a dozen to choose from. There is no point in picking 2 or 3 different growth funds and putting your money into each. Reason being that all three funds will be invested in several of the same stocks. If the funds do well, great. But if they don’t you’re going to feel three times the pain. There is no diversification with money in 3 growth funds so don’t do it, pick one growth fund and only one growth fund. It’s better that way.
When your picking the best growth fund (or any other type of fund) out of a group of a dozen or more, you’re looking for three things:
- The expense ratio and other fees
- The average annual return over 1, 5 ,10 year period and life of the fund
- The portfolio manager/s and the “managed fund since” date
The expense ratio is just the fee structure that can include the management fee, non-management expense, and the 12b-1/non-12b-1 fees. What all this means is that somewhere there will be an Expense Ratio = x.xx%, the lower the number the better. Look out for early redemption fees that will charge a percentage on the money taken out of the fund before a set time period. The less money you pay out the more money you’ll eventually take home at the end of the day. We want to reduce all of these fees to the lowest possible amount, but you still want to have one of the higher annual returns so don’t be cheap.
The average annual return will usually be broken down into 1, 5, 10 years and lifetime of the mutual fund. If it’s broken down more great, if not the 5, 10 and lifetime numbers are what is really needed. Just ignore the 1 year return, it doesn’t accurately tell you of the funds multi-year performance. With the number of funds available today, several haven’t even been around for 5 years or even 10 years, so lets avoid those immediately. What is left should have at least a 10 year average annual return, this will give you a good idea of the historical performance of the fund. Obviously the higher the number the better. If the 5 and 10 year returns are pretty close you know the fund managers are consistent. What this does is give you a general idea of what to expect from the fund in returns over the next 10 or more years, assuming the fund managers can maintain their track record.
Low expense ratio, check. High average annual return, check. Fund managers, check. All mutual funds have fund managers, but are they great fund managers? If you have a mutual fund that has had an average annual return of 10% over the past 10 years that’s great, but if the fund manager has only been there for 2 years, that return is useless. Someone else earned those returns over the first 8 years, the current manager is just taking credit for the 10 years. What you want to find is a mutual fund that has had at least one manager around the majority of that time period. It provides you with a proven track record and a little piece of mind as well. The more experienced the manager the better. You’ll get more consistent returns and they will minimize your losses on the down years.
When looking for a good mutual fund, find one with a low expense ratio, high average annual return and experienced fund managers. You’ll be well on your way to some great returns in the future.
