If you are thinking about investing in a mutual fund, or if your company-sponsored 401(k) retirement plan requires you to choose from a list, the options can appear daunting at first. Following a few key guidelines can simplify the selection process.
Here’s how to get started:
Invest for the long term. It is important to view mutual fund investing with a long-term mindset, says Henry To, partner at CB Capital Partners. “Realize that all funds have periods of short-term underperformance, and that you should stick to your funds and investment allocation when that occurs,” To says.
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Start with some homework. If you are investing in a mutual fund through a company-sponsored retirement plan, your options may be limited. Many 401(k) plans only offer funds through one fund family, or two at the most, To says. Research fund families and consider a number of factors.
“Check for stewardship issues. Does management have integrity? Avoid fund families who have had to shut down funds in the past or have seen some of their funds blow up. Check to see if there are any executive or fund manager turnover in the last three years,” To says. “Several departures, even for a large fund family, is a red flag, aside from retirement or health reasons. Finally, check to see if fund managers have a sizable stake in their own funds. They need to have skin in the game to stay motivated.”
Consider that passive or index funds may offer better performance. There may be two main choices you are offered in a company retirement plan: actively managed mutual funds and passive index funds, which track the performance of a benchmark index, such as the Standard & Poor’s 500 index.
“Actively managed funds have generally underperformed their passive counterparts over sustained periods of time. Unless you are highly confident about your manager and fund’s due diligence process, you should pick the passive option most of the time,” To says.
Decide how comfortable you are with risk. The younger you are, the more risk you can afford to take by tilting your portfolio more heavily toward stocks, says Charles Sizemore, founder of Sizemore Capital Management. Also, consider your personal risk tolerance.
“I like to use what I call the ‘sleep factor.’ If you’re having trouble sleeping at night, then you’re taking too much risk,” he says.
Avoid funds that charge a sales load. There is no reason to pay a sales load, a type of commission charged an investor. These fees can be charged at the time of purchase, sale or yearly. “With so many quality funds these days offering no loads, there’s just no good reason to pay them,” Sizemore says.
Pick funds with low expense ratios. According to Morningstar, funds that charge the lowest annual expenses have outperformed their higher-expense counterparts, To says.
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“For an actively managed U.S. large-cap fund, you should pay no more 0.70 percent in annual expenses; for an actively managed foreign large-cap fund, no more than 0.80 percent,” he says. “If picking a passive fund, the sales charge should be many times lower. For example, the Vanguard 500 Index Fund Investor Shares, with a $3,000 minimum investment, only charges 0.16 percent in annual expenses.”
Find out how long management has been on board. The longer the fund’s manager has been on the job, the better, Sizemore says. “A great historical track record means nothing if the managers that generated it are no longer running the fund,” he says.
Look for funds with low turnover rates. Turnover rate refers to the percentage of a mutual fund’s holdings that have been sold in the past year. “Fund turnover should be kept to a minimum — no more than 30 percent, preferably in an actively managed fund,” To says.
Consider these fund categories. Determine an investment allocation between stocks and bonds that is in line with your investment goals and risk tolerance.
Younger investors should have some equity exposure, as equities have been proven to achieve superior returns as long as capitalism remains the dominant economic system in the world, To says. “Within the equity space, investors should pick funds that provide the widest exposure to global equities, including exposure to Europe, Asia and emerging markets,” he says.
Retirees who are no longer earning an income, To says, should select inflation-protected bonds. And U.S government bonds are a safe-haven asset with capital-preservation qualities during a U.S. economic recession.
“The timing of a recession is uncertain, of course, but it is likely to occur at least once in most people’s lifetimes, including current retirees,” To says.
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Look at the size of the fund. Bigger may not be better. Managing more than $1 billion in a mutual fund can prove unwieldy, To says. “Size has been and is a detriment to performance. An actively managed fund that has done well when it had less than $1 billion in assets under management will find it difficult to outperform as more investors invest into the fund,” To says.
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How to Choose the Best Mutual Funds originally appeared on usnews.com
