For the vast majority of the general public, investing means investing in mutual funds. These convenient investment vehicles provide investors with a relatively easy-to-use, effective means to accumulate savings over the long run. Because of the mutual fund's important role in the investment activities of individual investors, it is necessary that they understand how to make informed decisions regarding fund selection and monitoring.
Whether you are a do-it-yourselfer, use an investment professional, or are a participant in a self-directed retirement plan, being reasonably conversant with the ABCs of a mutual fund is a valuable investing skill. Even if you do not have all the answers to the questions surrounding successful fund investing, you should at least be equipped with sufficient know-how to ask intelligent questions.
With the mutual fund universe at 8,000 plus and growing, there are, for many investors, just too many choices. The problem of choice is further complicated by an information overload, which requires investors to sort out what is nice to know and what they need to know.
Let's summarize the main points of assessing the investment qualities of a mutual fund, where to find this information and how to use it to make smart fund decisions.
Fund Investment Qualities
There are dozens of analytical financial metrics that can be used to evaluate a mutual fund. Some are quite complicated and difficult to apply. Here, we've covered just eight fundamental evaluative criteria, or investment qualities.
A fund investor would be well served to focus his or her attention on these summarized criteria:
- Fund Investment-Quality No.1: Investing Style Considerations
Evidence of a fund manager's ability and commitment, over the course of several years, to manage a mutual fund's assets according to its stated investment objective and avoid excessive style drift. (To learn more, read Focus Pocus May Not Lead To Magical Returns and Don't Panic If Your Mutual Fund Is Drifting.)
- Fund Investment-Quality No.2: Favorable Risk-Return Profile
Evidence of a fund manager's ability to effectively manage a mutual fund's assets by consistently producing as positive an investment risk-return spread as possible over the course of several years. (To learn more, read Financial Concepts: The Risk/Return Tradeoff.)
- Investment-Quality No.3: Fund Size and Style Compatibility
Recognition by the fund's manager that it is prudent to keep the size of a fund's asset base compatible with its investing style. (To learn more, read Are Bigger Fund Always Better?)
- Fund Investment-Quality No.4: Manager Tenure & Structure
A long-term fund performance record, preferably 10 years long, provides the best indicator of a manager's investing abilities. Accordingly, it is critical that managerial tenure and fund performance match each other over a meaningful time span.
- Fund Investment-Quality No.5: Low Portfolio Turnover
Whatever the category of mutual fund being considered, the lower the portfolio turnover percentage, the better, in terms of minimizing the cost of transaction commissions, which are not included in a fund's expense ratio.
- Fund Investment-Quality No.6: Be a Cost-Conscious Investor
When it comes to mutual fund costs and expenses, a mutual fund's investment quality increases with the absence of sales charges and 12b-1 fees and the presence of low expense and portfolio turnover ratios. Low-cost funds outperform high-cost funds. (For more on this topic, read Stop Paying High Fees.)
- Fund Investment-Quality No.7: Comparative Total Returns
A mutual fund's total return investment quality is evidenced by relatively consistent positive performance as compared to its peers, its category benchmark and an appropriate broad market index over five- and 10-year periods. (A 10-year period is preferable.)
- Fund Investment-Quality Number 8: Favorable Analytics
Positive analytical commentary by investment research analysts is an important indicator of mutual fund investment quality.
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Fund I-Q Scorecard
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