How To Pick A Mutual Fund Winner
Posted on March 6, 2008 in the Investing, Mutual Funds category
.The USA Today had an interesting article recently on how to pick a top performing mutual fund. While there approach differs slightly from mine (I prefer no-load funds, they don’t mind paying a sales charge) I thought that there approach they take when choosing a mutual fund.
Q: What about expenses?
A: Low expenses are one factor that can boost a fund’s future performance. Lower expenses are always better. Funds with small assets may have higher expenses because they’re more expensive to run. That said, we’d be pleased if more of the All-Star funds would lower expenses as their assets rose.
Q: When do you remove a fund from the All-Star list?
A: Typically, once its three- or five-year record dips below average. We’ll also dump a fund whose one-year performance has fallen into the bottom 20% of its peer group. A really dreadful year indicates inconsistency, and the All-Star criteria prize consistent performance.
A few funds, such as Davis New York Venture and T. Rowe Price Equity-Income, have been All-Stars for many years.
Q: What about sales charges?
A: We don’t care whether you buy a fund directly from the fund company or whether you buy via a broker who charges for the sale. But you should always factor in the cost of a fund purchase. Keep this in mind: If you pay a 5.75% sales charge on a $10,000 fund purchase, you’re forking over $575 to your broker for one transaction. Did she really provide $575 worth of service?
You can sometimes lower your sales charges. If, for example, you invest $9,000 in Davis New York Venture, you’ll pay a 4.75% sales charge. Invest $10,000, and the sales charge will drop to 3.5%.
Q: Should I put my money in just one good All-Star fund?
A: No. Any single fund should be part of a diversified portfolio. The three model portfolios are good examples to consider. They all fared better than the Standard & Poor’s 500-stock index, as well as the average stock fund. You can achieve further diversification by adding an international fund, if you like. Conservative funds might add a money market fund into the mix, too.
Q: What about taxes?
A: We look at fund performance before taxes, because many people invest in funds through tax-deferred retirement accounts. If, however, you’re investing outside an individual retirement account or a 401(k) plan, you should be sure to carefully review the fund’s history of capital gains and dividends distributions. Those distributions can cut your after-tax returns considerably.
Q: What about index funds?
A: They’re fine low-cost investments that typically perform exceptionally well over the long term. You might consider a broadly diversified stock index fund, such as Vanguard Total Stock Market Index, as a core holding.
You could then use an All-Star fund to tilt your portfolio in a particular direction you favor. MFS Value, for example, would give your portfolio a value-oriented tilt.
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The problem with these lists is that they are based on past performance. And numerous studies have shown that “past performance is not indicative of future returns” is not just legal mumbo jumbo you read in disclaimers, but rather the cold harsh reality.
You did highlight some important points in the Q&A: minimizing costs is paramount, and index funds perform exceptionally well in the long term.