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A mutual fund is a pool of stocks, bonds or other securities that has been divvied up into shares for an investor to purchase. Whether the mutual fund is actively managed or passively managed (like an index fund), it offers an efficient way to diversify a portfolio. As with any investment, evaluating a mutual fund's performance and choosing one or several that meet your investment goals and risk tolerance involves thorough research. Here are three steps to review a mutual fund and decide if it is the right choice for your portfolio.

First, classify the mutual fund to determine if it fits within your scope. For example, if you are seeking a mutual fund that provides steady income, a mid-cap value fund, which is growth-oriented, will leave you very disappointed. To find out the style of mutual fund, look it up on a financial-investment tracking website such as Morningstar that offers the basic facts and performance data, along with tools that further help you evaluate the fund. In your categorization of the mutual fund, also identify a few peers, or competitive vehicles from other fund companies, to compare it with. Using a mutual fund screener tool, such as the one provided by Morningstar, can help you with this task.

Next, review the historical performance data and compare your chosen mutual fund with a few of its peers. Look at the risk-return trade-off for each fund and determine whether it meets your risk tolerance. Morningstar ranks each fund's risk and historical returns against other funds within its universe so you can easily determine if a fund assumes a greater risk than average. The ideal balance between the two, the risk and the returns depends, again, on your risk tolerance and investment objectives.

Dig deeper into the historical performance numbers to determine the consistency of the fund's returns. Do the five-year average returns look great because of one phenomenal year that could have just been luck? Try to select a fund that consistently outperforms its benchmark and one that has withstood a few market downturns and mitigated downside risks. These numbers illustrate the ability of the mutual fund managers. Sometimes, however, when the market crashes, not even the best managers can save a portfolio from a loss. For this reason, also compare the fund's upside and downside data against comparable funds.

Finally, take a look into the fund's expenses and fee structure. Tactical mutual funds that have heavy trading or are very actively managed have higher annual expenses. Factor in these costs, as they directly affect the real rate of return you'll get. While a fund that charges higher management fees is not necessarily better or worse, you should still be cognizant of a reasonable expense ratio for the type of fund you choose. Again, comparing the fund with its peers can help.

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