In part one; we began our search for the right mutual fund by narrowing our list to 25. Now that we have a reasonable number of choices to sort through we can begin to review each fund individually. The goal is to continue to eliminate funds that are not the right option.
To start with I looked at the following in Morningstar (Morningstar – Independent. Insightful. Timely. Premium Membership – Get your FREE 14day Trial!)* and on the fund companies’ website. The website can be found on Morningstar. When you go to the sites find the fund and download the prospectus.
- Expense ratio
- P/E (price to earnings ratio) – There is a lot of controversy in the validity of this measure, but I still like to look at it to make sure there is not too much over valuing going on in the market. This is especially important in times of bubbles and general strong markets. The “hot” stock often gets pushed to levels that beyond practical for their projected earnings. I tend to look for funds under 20 preferably in the 14 – 18 range.
- Tax exposure – this is especially important if the mutual fund is going to be held outside of a retirement account or other tax protected account. This will help you get a feel for how much impact the fund will have on your taxes.
- Management – I like to ensure that the managers have been there for a while. I also like it better when there is more than one manager. Just in case something happens you have more than one person. This is not a complete deal breaker for me if everything else looks good and the company shows they are prepared for the unexpected (such as a large staff of analysts that could step up).
- Returns – at this stage I am looking to see how they have done against the market and their peers. I am not just looking at recent returns but for the life of the fund. Can they consistently perform or are they a onetime hit?
- Portfolio information – here I really am just trying to get a feel for the fund and see if anything jumps out at me that I don’t like.
- Style box – make sure they match what you are looking for here. Many funds may be categorized as one thing but in practice be another.
- Top 25 holdings – I have never nixed a fund because of this, but it gives me a feel for what the manager likes.
- Number of stocks in the fund – this is a balance thing, too few and it can be riskier (less diversity), too many and you have to wonder how much the manager knows about what they are investing in.
- Balance of the portfolio
- Foreign Stocks – many domestic funds are allowed a certain percentage that does not have to specifically match the objective of the fund. Just helps to know exactly what you are getting.
After reviewing these items for each fund I determined that I needed to go back and adjust some of my initial criteria that I had started my search with. I mainly decided this because too many of the funds were similar to each other. Following is how I adjusted the search.
- Expense ratio was lowered to less than or equal to 1%. I did this because the differences between the funds with a higher expense ratio did not justify the added expense. Expense can be a large factor in the lifetime success of your funds. Every tenth of a percent is that much more money not going in your pocket! If you can find a fund with low expenses and it is equally as good as one with higher expenses you always want the fund with low expenses!
- I added trailing returns for 5 years is greater than category average. I added this to ensure that even though they did great over the last 10 – 15 years that they still had a solid track record. I was beginning to see what used to be solid funds not having as great a return. I want my funds to be both good today and have a great track record from the long run. Don’t chase recent returns, chase good funds that are proven over both short and the long run. (I did not add the 3 year option because there is way too much volatility in the 3 year time frame. Everyone can hit a rough couple years, your stellar funds will get that back on track by the end of 5 years, plus the market is more stable over the long term).
- Added that the “special fund type” was not a “fund of funds”. Fund of funds are mutual funds that are made up of different types of mutual funds. I typically like to stay away from this as it tends to add additional expenses and I like more control over the entire portfolio. I would rather buy each one individually. It can broaden your exposure to different areas of the market, but I believe this can be accomplished through a good well diversified mutual fund plan. Especially when we are looking at equity growth funds and not a mixed set such as stocks and bonds.
Next round we will continue to narrow down our list and get more into what to look for. Have questions let me know! Till next time, happy investing.
*Affiliate