WASHINGTON — In 2016, 44 percent of US. households — or about 54.9 million people — owned mutual funds in their retirement and investment accounts, according to the Investment Company Factbook.
The median amount invested in mutual funds is $125,000 making them a major component of many US households’ investment wealth.
Given that so many of us invest in mutual funds, it’s important to understand what they are, how they work and how to know if you have selected the right mutual funds that best achieve your goals.
In part 1 of “How to think like an adviser: The basics of mutual fund investing,” Nina Mitchell, senior wealth adviser at Bridgewater Wealth, provided a great primer on how to analyze mutual funds for your portfolio. In Part II, we want to arm you with questions that you can use to decide whether a specific mutual fund is a good investment for your portfolio.
The relevant questions differ slightly, depending on whether you are selecting and managing a fund on your own or assessing the quality of investments recommended to you by a professional such as a broker, investment adviser or financial adviser.
Also, consider that performance is only one dimension of the benefits you receive from a particular mutual fund investment. Factors such as tax efficiency, risk, expenses, and deciding when to buy and sell contribute to the overall return and should be considered during your analysis of when and where to invest your money.
Let’s begin with a list of questions that apply to both do-it-yourself investors and investors who are working with a financial adviser or broker. These initial questions may help to determine the quality and appropriateness of the mutual fund you are considering:
- What is the main goal and investment objective of this fund? (Does it fit into your investment goals and objectives?)
- How much will I pay in internal expenses for this fund? (Are the fees reasonable compared to other similar funds?)
- Has this fund performed in-line with the relevant comparison index? (If this is a U.S. Large Cap fund, how does it compare with the S&P 500? If it’s a bond fund, how does it compare with an Aggregate Bond Index?)
- Who manages this mutual fund? (What do you know about the fund managers and their investment philosophy?)
- Would the underlying holdings of this fund diversify my portfolio, or do they hold investments I already own? (How does their top 15 holdings compare to other investments that you own?)
Get the facts by reviewing a fund fact sheet
All of these questions can be answered by reviewing a fund fact sheet. If you are a do-it-yourself investor you can find the fund fact sheet online directly from the mutual fund company or through a security information source such as Yahoo Finance or Morningstar. If you are using an adviser, we recommend you request the fund fact sheets directly from them. Securities regulations intend that these fact sheets be understandable for an average investor, and mutual fund companies are required to include specific standard information in this document.
Do-it-yourself investors
In addition to reviewing the fund fact sheet for each mutual fund investment, if you’re a do-it-yourself investor, ask yourself questions about the purchase, ongoing management and selling process you’ll use for this investment. Start by considering the following:
- How will I monitor the performance of the fund on an ongoing basis?
- What events would cause me to consider selling the investment? Do I have the discipline to stay invested through a down market?
- What is the appropriate placement of this fund — in my retirement or my taxable account? (Do you understand why location matters?)
- Do I need this investment to be liquid on a moment’s notice? If so, are there any liquidity limitations on this fund?
For more information on how to construct an investment portfolio, read “Investment Soup: A Recipe for Financial Success.”
Investing through a financial adviser or broker
If you have hired someone to purchase mutual funds on your behalf, some important areas to explore include fees the adviser will charge (this helps determine the extent to which their advice may be biased by their own compensation) and whether they have a well thought-out and consistently executed investment philosophy. We recommend you ask the following questions for each investment an adviser suggests for you:
- What fees and commissions do you receive if I invest in this fund?
- Are there any back-end loads (meaning fees) if I decide to sell this fund in the near-term?
- Do you have access to lower cost Institutional share classes?
- What is your firm’s investment philosophy and how does this fund reflect that philosophy?
- Do you favor active or passively managed funds?
- How does this fund match with my Investment Policy Statement?
- How do you analyze and decide when to buy, hold, or sell a fund? Will you buy this fund in one purchase or dollar cost average?
- How often will you rebalance my entire portfolio?
Know what you own and why
Selecting a mutual fund may seem like a complicated task. You can simplify the selection process by starting with a clear understanding of your overall investment objectives and risk tolerance. Use that criteria to narrow the field of choice to only those funds that match your specific portfolio objectives. Then utilize these questions to help you select the fund that provides the best balance of performance, expenses, tax efficiency and liquidity.
If you are outsourcing your investment process to a professional adviser, start by determining whether your adviser has a disciplined investment methodology and assess how that philosophy aligns with your long-term goals.
Being an informed investor will help you to stay in control of your investments and ultimately, the goals you want to realize over time.
