How to choose mutual funds
It seems like everyone is catching mutual fund fever
these days. All those funds claim to offer low risks and good returns
on your investment. But they can't all be telling the truth, can
they? Of course not. Choosing the wrong fund can leave you feeling
more anxious than a prisoner the day before a conjugal visit.
Funds can be loaded with fees
The good news is that learning how to choose the right
funds doesn't have to be complicated. You don't even need to have
big bucks in order to get started investing. Gene Walden, author
of The Top 100 Mutual Funds, states that you'll need about
$500 to $2,500, depending on which funds you buy. Once you've made
your initial investment, you can then add as little as $50 per contribution,
according to Walden.
As a beginning investor, your first step should be
to understand the basics of mutual funds. There are two kinds of
mutual funds for you to consider -- load funds and no-load funds.
Load funds are those that charge a sales commission. However, that
doesn't mean those funds will necessarily bring you a higher return
than no-load funds.
If load funds don't guarantee a higher return, then
why do people buy them? The reason is because some investors think
a stockbroker's advice is sometimes worth the added expense. Also,
no-load funds aren't always the bargain they seem. Those funds can
still carry management fees (12b-1 fees) or advertising expenses
even if they don't charge a commission. Still, experts don't always
agree over the value of paying commissions.
"I advise people never to buy a load fund because
there's always an equivalent no-load fund out there," says Paul
Farrell, mutual funds editor for CBSmarketwatch.com. "Why put up
5 percent of your money upfront? There are some load
funds that do better than the competition. However, if you look
at their earnings after taxes then they're not performing as well
as they originally seemed. Stockbrokers will tell you that those
expenses will even out after a five-year period. The problem with
that logic is that many people are getting out of a fund after two
to three years."
"If your broker gives you the recommendation, pay
the fee happily," argues Walden. "But if you do your own research,
then you should probably be biased toward no-loads."
Five keys to picking a fund
If you're an enthusiastic investor, you'll be glad
to hear that some professionals have written entire books about
how to choose a fund. I'm not that ambitious, so I'll just provide
some simple guidelines to get you on the right path.
Set investments goals.
Ideally, mutual funds are geared toward long-term investors.
However, market returns have been so good in the past few years
that investors have been pulling their money out much sooner
than normal. Keep in mind that your financial goals are going
to vary widely depending on your age. Having time on your side
means that you can afford to be more aggressive with your investments
-- since you have more time to recover from an unexpected loss.
Learn the signs of
a well-managed fund. You're not going to have
trouble finding out details about any fund, so you need to know
what to concentrate on rather than risk information overload.
Walden recommends that investors focus on a fund's performance,
management and consistency.
"I want funds that rank near the top of the list in terms of
five-year returns; then I want to be sure the fund manager has
been there several years, and I want a fund that is consistent
year to year relative to the overall market," says Walden.
Understand the risks.
In general, mutual funds are not considered to be too risky
because they invest in dozens or even hundreds of stocks. Still,
be careful to read the part of the fund's prospectus that talks
about risk. Farrell, author of "The Winning Portfolio," warns
that you shouldn't be fooled into thinking you can't lose any
money on these investments.
"There are a lot of funds that haven't done well even with the
strong market," he says. "Small cap funds have lost 10 to 20
percent of their portfolio value recently. Funds involved in
emerging countries have also done poorly. ... The American Heritage
fund was the No. 1 performing fund two years ago, before it
became heavily invested in a failed drug. ... The fund went
from $100 million in holdings to about $3 million."
Study your resources.
All funds have toll-free telephone numbers, so you can call
them to get information and ask questions. Companies will also
send you a free prospectus that explains the principal strategies,
objectives, risks, performance and fees associated with a fund.
In the past, these documents have been as easy to read as a
set of encyclopedias. However, funds now offer a simplified
"fund profile" that covers the highlights in three to six pages.
The financial news media and companies like Morningstar, a popular
mutual fund rating and data firm, are also great resources.
Dump what doesn't work.
Farrell suggests that investors carry no more than eight to
10 funds in their investment portfolio at any time. You don't
need to panic if some of your funds aren't kicking tail, but
it's still a wise idea to reevaluate your portfolio every three
to six months.
"There will usually be one to three funds in that
group that are subpar performers," says Farrell. "If they are below
the middle of their peer group for four consecutive quarters, then
investigate the reasons why, and make the necessary changes."
Following these steps won't guarantee you a spectacular
return on your investment, but you'll be much less likely to end
up losing your investment. Here's one final piece of advice: Don't
underestimate the value of diversification by putting all your money
into one single fund. People who put all their eggs in one basket
may come home to find someone's been making scrambled eggs in their
-- Posted: July 2, 1999