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How to Choose Mutual Funds

Guest Author - Tony Daltorio

One of the most common ways that the individual investor invests in the stock market is through mutual funds. There are literally thousands and thousands of mutual funds in the marketplace from which to choose from. It can be quite a time-consuming task for an investor to research all of these funds and then to decide which funds to invest in.

Fortunately, there are many sources of information on mutual funds which an investor can use to research the funds. The leader in the field of mutual fund research is, of course, Morningstar. Other good sources of mutual fund information can be found at Yahoo Finance, MSN Moneycentral, and at online brokerage firms such as E-Trade and Schwab.

How can an individual investor choose among all the various mutual funds? What criteria should the individual investor be looking for? Some of the more obvious criteria would be the performance of the mutual fund and also the fees charged by the mutual fund companies.

The investor should check the actual track record of the fund. See what the fund actually returned. Some funds shamelessly advertise that they beat the 'benchmark' consistently. Do not fooled by this old Wall Street 'game'. The fund companies love to show charts of their fund versus the S&P 500 index. If the 'benchmark' is say down 20% and a fund beats the benchmark, so what? You may have still lost money! Make sure the fund is actually making you money.

With regard to the fees, many investors don't dig deep enough. They look to see whether the fund is a load fund or a no-load fund and they stop there. Every mutual fund investor should dig deeper to see what other fees are charged. Some fund companies charge 12b-1 fees. These fees are fees the fund companies charge their shareholders to advertise their funds. I do not care for the 12b-1 at all.

The other important fee to look at is the management fee. This is basically the fee that fund companies charge their shareholders to actually run (pick the stocks,etc.) the fund. These fees should be as low as possible and at most 1% for domestic funds and 2% for international funds.

The most important item that mutual fund investors should look at is the actual stock portfolio of the particular mutual fund. What does your mutual fund actually own? Many mutual funds have a dismal track record. Why? Are the fund managers just dumb? I believe that the reason for many mutual funds poor performance is that they are too diversified. That is, the funds own far too many stocks. So even if a fund manager picks some big winners, the effects are diluted by the many stocks that have done nothing or have gone down.

I believe that a fund manager (and individual investors too) should actually think about the big picture. Where is the economy headed? What are the global mega-trends? And then the manager should invest accordingly into, I believe, no more than a hundred or so stocks. If the fund manager makes the right choices, the fund definitely will make a lot of money.

Why don't more fund managers invest that way? Again, it is the Wall Street game of beating the 'benchmark'. Many fund managers get paid to simply beat the 'benchmark'. So many fund managers just don't want to risk losing their big bonuses for 'beating the benchmark'. So even if your mutual fund lost money, as long as the fund manager beat the benchmark, they collect a big year-end bonus.

In order to get a decent return on their money, investors should look for a fund manager that doesn't play these games and has a reasonable portfolio size of approximately a hundred stocks. A good example of this would be Ken Heibner of the CGM funds. His CGM Focus fund actually has only 25-35 stocks in it and yet the returns are fabulous. The fund has a 10 year annualized return of over 25% and a 5 year annualized return of over 30%! Even this year where the stock market has stunk, the fund has returned nearly 7%. So there are great fund managers are there, you just have search for them.
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Content copyright © 2014 by Tony Daltorio. All rights reserved.
This content was written by Tony Daltorio. If you wish to use this content in any manner, you need written permission. Contact Sandra Baublitz for details.

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