You’re ready to invest in mutual funds – but with thousands of funds to choose from, the options can feel overwhelming. The 6 steps below will help you quickly pinpoint the best funds for you, so you can get started right away.
Once you’ve figured out the types of funds you want to invest in (small-cap stocks, large tech companies, or municipal bonds, for example), you’ll need to do some homework to narrow down the options. The best sites to use for your research include:
- FINRA Mutual Fund Analyzer, offering information and analysis on more than 30,000 funds, including an in-depth look at how their fees and expenses will affect your investment
- Kiplinger Mutual Fund Finder, which can help you find funds that fit with your financial plan
- Morningstar, an independent investment research firm
With those easy-to-navigate sites, looking into these 6 fund-selection factors will be a breeze, and you’ll be able to make sure the fund you choose will be the best one for your portfolio.
- Go with no-load. Loads are sales charges that work sort of like commissions. For example, if you have $2,000 to invest in a mutual fund with a 5% load, $100 of your investing money will go straight toward that sales charge, leaving you just $1,900 to invest. That’s why loads can take a serious toll on the compounding power of your money. You’ll keep more of your money working for you if you stick strictly with no-load funds.
- Maximize returns with index funds. There are two main types of mutual funds: active (managed) and passive (index). With active funds, financial professionals select every stock (or bond) in the mutual fund, hoping to outperform a benchmark index (what they use for comparison). Because the fund has to pay those professionals, they typically charge higher fees. Passive funds, on the other hand, model their portfolios after the benchmark index itself, keeping costs as low as possible. What’s more, passive funds do better than active funds most of the time. That’s a double bonus for passive funds: lower costs AND better performance. Learn more about passive index investing here.
- Look for a low expense ratio. All mutual funds charge expenses – it’s the cost of owning a fund – but the amounts can vary widely. When two funds are essentially the same (like two different S&P 500 index funds), the one with the lower expense ratio means higher returns for you. And even though the differences may seem too small to matter (0.08% vs. 0.35%, for example), the difference in your earnings over time can be huge.
- Look at the long-term returns. Most funds will perform well when the stock market rallies. It’s funds that show solid returns over long periods of time, weathering market downturns, that hold the most promise for future growth. Keep in mind: past returns don’t guarantee similar future returns, and funds that have grown steadily in the past could tank in the future. But you have a better chance of success if you choose among funds with better long-term track records.
- Stay away from funds with high turnover ratios. Turnover refers how often the stocks (or bonds) inside a mutual fund get bought and sold. Here’s why that matters: Every time they sell pieces of the portfolio, they create a taxable transaction for you (unless you’re investing through a retirement account like a 401k or an IRA). So high turnover almost always leads to a higher tax bill for you, and those taxes eat away at your earnings.
- With managed funds, the manager really matters. If you decide to go with a managed fund, look into the portfolio manager. What kind of info matters here? Look for:
- Typical turnover ratio
- Longevity: how long they’ve been managing this fund – look for at least 5 years
- Loss history, especially during times when the markets are performing very well
- Long-term track record with this fund and any others they’ve managed
You can also find articles about the managers online, and check out their letters to fund holders so learn more about their investment philosophy. Here’s a good article on evaluating mutual fund managers from Investopedia.
Bottom line: The number of mutual funds and the amount of available information can be overwhelming, so focus on these 6 factors to help you make your choice.