Investing Unit 6: Find the Right Mutual Fund



Now that you are familiar with the various types of mutual funds, here are some specific guidelines for picking them.

Step 1. Identify the types of funds you need (e.g., growth) to reach your goals.

Getting started will be easier if you first focus your search on a specific type of fund with a specific investing objective. Eventually, your goal should be to build a portfolio that includes both stock and bond funds with various investment objectives and investment styles for maximum diversity. This portfolio allocation process involves assigning appropriate percentages of your total investment portfolio, no matter the size, to interest-earning (income) and stock (growth) investments. You can purchase them gradually, perhaps starting out with a balanced fund, an asset allocation fund, a lifestyle fund, or a broad-based index fund such as a “total stock market” fund. The latter tracks 7,000+ large, medium, and small U.S. companies and is offered by fund families like T. Rowe Price, Vanguard, Fidelity, Charles Schwab, and others.

Step 2. Do more reading.

Visit the library or buy some specialized books on mutual fund investing that will build on what you have learned from this unit. Some useful references are: Mutual Funds For Dummies by Eric Tyson, (For Dummies, 2007), Morningstar Guide to Mutual Funds: Five-Star Strategies for Success (Wiley, 2007) and Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor by John C. Bogle (Wiley, 2000).

Step 3. Do some research on specific funds.

There are excellent tools to help with the process of narrowing the list. Personal finance magazines publish their “best buy” lists generally twice a year in February and August (e.g., Money, Kiplinger’s Personal Finance Magazine, Business Week and Forbes). Barron’s and The Wall Street Journal publish a quarterly Mutual Fund Review that reports on all funds’ categories and objectives, current and past performances, as well as fee structures. Also, the Investment Company Institute has excellent, free publications on mutual funds.

Once you spot several funds that have consistently performed well and are aligned with your goals, go to your library’s reference section to complete your research. Rating services such as Morningstar and Value Line Mutual Fund Survey provide current data on mutual funds with a one-page report on each. This makes it easy to review and compare funds you are considering. Look at 3-, 5-, and 10-year periods. Last year’s high flyer could be this year’s dud.

Step 4. Determine your selection criteria and eliminate funds.

You can whittle down the over 8,000 fund universe to a manageable list in short order by using a few criteria to help with the elimination process. For example, suppose you are looking for a stock fund to invest for retirement. Right there, you have cut the number to a little over 5,000 funds by eliminating all the bond and money market funds. Perhaps you will toss out all funds that have a sales commission, all stock funds with an expense ratio over 1.4%, funds that have an investment minimum over $3,000, any fund where the manager’s tenure is less than 5 years, and all funds that have not outperformed 60% of comparable funds over the last 3 and 5 five years, etc. Applying these criteria as you research your favorites, pay most attention to performance, cost to invest, and risk.

Step 5. Call or write for a prospectus.

A prospectus for a mutual fund is the selling document legally required to be distributed to mutual fund investors. It describes the fund’s investment strategy as well as the risks and costs of an investment.

Step 6. Make your purchase.

While you can always do business by mail, and in some cases, at a local investment center, most mutual fund groups offer a toll-free number for telephone assistance. Of course, if you are buying a fund with a sales commission, the broker or financial planner executes your order.

Step 7. Continually buy more shares.

One of the best ways to grow your investments is to use a dollar-cost averaging strategy—investing a fixed number of dollars (e.g., $50) in a mutual fund(s) at periodic intervals, usually monthly or quarterly. (See Unit 8.) When the price of the fund is low, your dollars buy more shares. When the fund’s NAV moves higher, you will buy fewer shares. Although dollar-cost averaging does not guarantee you a profit, in most cases your average cost per share will be less than the current price.