There are more than 15,000 mutual funds to choose from! Knowing how to wade through this sea of choices can cause the best of us to throw up our hands in despair. The reality is, however, that evaluating a mutual fund is really quite simple.
So if you have 60 seconds to spare, here’s how you can quickly evaluate a mutual fund.
Table of Contents:
Start with Morningstar
Go to Morningstar and enter the fund’s ticker symbol in the quote box at the top left. Press enter. This will take you to the Snapshot of the fund, which contains most of the information we’ll need for our evaluation.
3 Quick Mutual Fund Checks
The next step is to look at three factors that could quickly eliminate the mutual fund from consideration.
The first item of business is to make sure the fund is still open to new investors. Funds close to new investors when the amount of money in the fund becomes too large to manage effectively given the fund’s investment objectives. In the fund’s Snapshot, look for the “Status” label, which will tell you if the fund is open or closed.
No-load funds only
Next, make sure the fund doesn’t charge front-end or back-end fees called loads. With so many excellent no-load funds, there is simply no good reason to pay a sales charge. What you need to look at is the “Load” on the Morningstar Snapshot. No load funds will show “none.”
I’ve said it before, and I’ll say it again–expenses are one of the single most important factors in picking a fund. That’s why I avoid funds with sales charges, and why I seek funds with low expense ratios. My rule of thumb is not to pay more than 1% for actively managed funds and no more than 0.50% for index funds. Most U.S. stock index funds are considerably less, some around 0.10%. You’ll find the fund’s expense ratio at the top of the snapshot. For more on fund costs, check out How to Find The Hidden Cost of Mutual Funds.
Investment Style and Performance
If the fund passes the above tests, next dive into the investment strategy and performance of the fund.
The style box
Before picking a fund, you should know what asset class you want to add to your portfolio. Are you looking for a large cap growth fund, for example, or a small cap value fund? You can read more about asset allocation in a series I’ve been writing.
Scroll down from the top of the Snapshot and you’ll find the Morningstar Style Box. This will quickly tell you the market capitalization of the fund and whether its investments are value, core or growth.
Foreign vs. Domestic
You’ll also want to know whether the fund invests in the U.S., overseas, or both. You can quickly determine that from the Snapshot. Morningstar provides the “Category,” which tells you the geographic concentration of the fund. From there you can dive down into more details as necessary.
Much has been said about not relying too heavily on past performance. The truth is, much of our investing decisions are made on past performance, but with the recognition that we don’t know what the future holds. All of that is why, in my opinion, index funds should represent the core investments for must of us.
That said, I always look at the 3, 5 and 10 year performance statistics of a fund as compared to its comparable index. The quick and easy way to get an initial assessment of risk adjusted performance is the Morningstar star rating. However, don’t rely just on the star rating you see on the Snapshot.
Instead, click on the “performance” link just below the star rating. This link brings you to a more detailed listing of the fund’s performance, including comparisons to the relevant index, for 3, 5 and 10 years. I look for funds with three stars or better. Again, a more detailed analysis of a fund’s risk adjusted performance can be made, but the star rating is a good, simple place to start.
Particularly for actively managed funds, you want to see that the fund’s managers have been at the helm for a number of years. There’s no magic number here, but I like to see that a fund’s top management has been at the fund at least 5 years. Otherwise, the great performance the fund has enjoyed may be due to personnel who have since left the fund. Hitting the back button to return to the Snapshot will show you this information, including the name(s) of the managers and their start dates.
Is there more to evaluate before actually buying a fund? Sure, but this initial assessment will go a long way to narrowing down the many options. And 9 times out of 10, this quick evaluation identifies the fund(s) I actually end up buying.