Analyzing mutual funds

As you begin your search for mutual funds, make sure that
your performance evaluation produces meaningful results.
Performance is important because good, long-term earnings
enable you to maximize your investments and ensure that
your money is working for you. Gauging future performance
is not an exact science.

A fund’s prospectus, which you can
request from a fund’s toll-free phone number, also outlines
the important features and objectives of the fund.

As an additional check on your selection process, compare
all your choice funds before making a final decision; avoid
choosing one fund in isolation. A single fund can look spectacular
until you discover it trails most of its peers by 10%.
Look for the following information when you select mutual
funds:

 One-, three-, and five-year returns: These numbers
offer information on the fund’s past performance. A look
at all three can give you a sense of how well a fund fared
over time and in relation to similar funds.

Year-to-date total returns: This is a fund’s report card
for the current year, minus operating and management
expenses. The numbers can give you a sense of whether
earnings are in line with competing funds, out in front,
or trailing.

 Maximum initial sales charges, commissions, or
loads: Unlike stocks and bonds, mutual funds have builtin
operating and management expenses. These expenses
are in addition to any commission you may pay to a broker
or financial planner to buy a fund. A sales charge on
a purchase, sometimes called a load, is a charge you pay
when you buy shares. You can determine the sales charge
(load) on purchases by looking at the fee and expense
table in the prospectus. No-load funds don’t charge sales
loads. There are no-load funds in every major fund category.
However, even no-load funds have ongoing operating
and management expenses.

Go for lower-priced funds or no-load mutual funds,
which by definition must have expenses no higher than
0.25%. Load funds can have charges of up to 5.75%.
What that means is that you must deduct that 5.75%
from any annual performance a fund turns in. If it’s
10%, you can expect to earn 4.25% after you pay the
load or commission.

 Annual expenses: Also called annual operating expense
ratios (AOERs), these costs can sap your performance.
Before you settle on one fund, review the numbers on at
least a few competitors to determine if the fund’s
expenses are in line with typical industry charges. In general,
the more aggressive a fund, the more expenses it
incurs trading investments. Before you invest in a particular
fund, be cautious if it has an extremely high
AOER compared to that of similar funds.

To develop a sense of how expenses can take a big bite
out of earnings over the years, consider this example: A
$10,000 investment earns 10% over 40 years with a 1%
expense ratio, which yields a return of $302,771. The
same investment with a 1.74% expense ratio returns
$239,177, or $63,594 less.

Manager’s tenure: Consider how long the current fund
manager (or managers) has been managing the fund. If
it’s only been a year or two, take that into consideration
before you invest — the five-year record that caught your
eye may have been created by someone who has already
moved down the road. Fund managers move around a
often. In an ideal world, your funds are handled by managers
with staying power.

 Portfolio turnover: This tells you how often a fund
manager sells stocks in a the course of a year. Selling
stocks is expensive, so high turnover over the long run
will probably hurt performance. If two funds appear
equal in all other aspects, but one has high turnover and
the other low turnover, by all means choose the fund
with low turnover.

 Underlying fund investments: For your own sake, take
a look at the top five or ten stocks or bonds that a fund
is investing in. For example, a growth fund may be getting
its rapid appreciation from a high concentration in
fairly risky technology stocks, or a global fund may have
more than 50% of its holdings in U.S. stocks. Neither
of these strategies is a mortal sin if you know about and
can live with it. If you can’t, keep looking for a fund that
matches your goals. Looking at underlying investments
not only helps minimize your surprises as markets and
economies shift, but also enables you to create a balanced
portfolio.