How to choose a Mutual Fund, Part I

How to Choose a Mutual Fund Part 1

How to Buy a Mutual Fund

For the average investor and even sophisticated investors that do not have the time to research Stocks and spend a lot of time on investment research, Mutual Funds are a fast and flexible way to grow your wealth.

One of the best features of a Mutual Fund is that it provides a relatively low cost to Diversify your money. 

Another helpful feature of Mutual Funds is that they help save you time.  A well-selected Fund reduces your research time and the need to constantly monitor the market.

Historical perspective:

Aggressive U.S. Growth and U.S. Growth Funds have been the top performing Type of Funds.

With any top performing fund comes volatility and “Risk”, and even though these types of funds go up and down more than others, it has been historically proven to generate more wealth for the Long-term investor when compared to “safer” conservative Defensive funds, Income Funds, Growth and Income Funds, not to mention Bond Funds.  All of these previously mentioned funds have lagged and sometimes significantly when compared to Aggressive Growth and Growth Funds over the long-term. 

OK, OK. We get it, how do we pick our Fund???? 

This year’s Top Performer

Over the last year (as of 3/24/17) Small Cap Growth Funds have outperformed all other Fund Types.  Before you dive straight in, take a closer look at what you are about to invest in. 

Small:  Just because your fund is small in terms of Assets Under Management doesn’t mean it’s a bad fund, however, if large amounts of cash comes rolling in, it’s going to be very tough for the management team to continue to invest in small companies.  As the assets of a fund grow, management is forced to put that money to work and they end up investing (being forced to) in Mid-Caps, Large Caps and other type investments.

Tip:  Every Six months or so check your Fund to make sure they are still investing in the type of Investments you original signed up for.

Below Average or Low Average: All Funds go through poor periods, it’s inevitable.  Pay close attention to the funds you plan to invest in and especially the Fund you already own when their three-year return Grade or Stars reach Below Average or Low Average.  It may be time to say goodbye.

Tip:  When a Fund you own or are looking at investing in has Below Average or Low Average cross check it with another fund or two in the same exact category.  It may be the sector, Industry or Style is in a down period.

No Grade at all:  New Funds and/or Young Funds do not have the history yet to have a ranking, Stars or Average.  This is not necessarily a bad thing but here at Welcome to the Nerdery require at least Three Years to rank and evaluate Funds. 

Just because the Fund you own or are considering doesn’t have a three-year track record yet doesn’t mean it can’t become a Rockstar but we do not know how it will act or perform when the market gets tough or worse, goes through a Bear Market.

Tip:  If the Fund you own or are considering to invest in does not have a Three-year Track record, look at the Managers History.  If he or she came from another fund with an above average track record, Ranking or Star, you are probably good to go.  If this is a brand-new manager with no track record, look elsewhere.  There are a million (exaggeration) Funds to choose from, why add risk with an unknown entity?

What’s in a name?

Most investors take for granted that the name of the fund is what management actually invests in.  I’ve seen Large Cap Value funds invest more than 80% of their assets in Small and Mid-Cap Technology stocks.  I’ve seen Small Cap Growth Funds turn into a Large Cap Value Fund.

The Market is constantly rotating to the next great Industry or Sector or it times it favors Small companies, Large companies or even Mid-Caps.

Fund Managers are constantly trying to increase returns and prove themselves to gain more money, new investors and quite frankly to have bragging rights.  The Way they try to do this is to invest in what’s hot now, what the market is favoring at the moment.

This is all well and good if they allocate some money towards these flavors of the month, quarter or year but the reason we choose a particular fund should not be compromised.  We did not invest in a Large Cap Growth Fund to have all of our or most of our money invested in Small Cap Value Stocks.

Tip:  Every Six months or so check your Fund to make sure they are still investing in the type of Investments you original signed up for.

In my Paid Course, I teach you how to use Morningstar to make these checks in a few steps so you can get back to the life you want.

The Criteria laid out in this post is tailor-made for Passive, long-term investors.  History has proven that Growth Funds have over the long-term, outperformed other Investment Style Funds (Diversified/Fixed Income/Growth and Income Funds, etc. etc.).  Furthermore, Focusing on Growth Funds with Above Average to Great Ranking, Stars or Grades with Three-year or more track records do well over many different market cycles.

How does my Fund Stack up?         

When you want to know how your fund is performing or you want to see how your Fund compares to others, start by comparing your funds Quarter to date, 1 Year return and Three- year returns to a corresponding Index.

If you own a Large Cap Fund, one Index you can compare your Fund to is the Dow Industrial Index Average.

The Dow was once the benchmark to gauge how our Economy was performing.  To some people, The Dow is what people reference when they say how the market is “doing”.  Today, while the Dow is important, it is still only made up of 30 stocks.  These thirty stocks barely represent the overall universe of all available companies that make up our economy.  The Dow is heavy on Economically sensitive stocks and thin on Technology.

The other downside of tracking the Dow as a total barometer of our economy is if one of those 30 stocks has a really good or bad day, that one stock can exaggerate the index price action for the day. 

A better Index to compare Large Cap Funds against is the S&P 500 Index.  The S&P is a better, broader index that encompasses more Industries and sectors that represent the best of the best Large companies.

The S&P is still not perfect, as it too is under-represented by Technology companies, but still a better more closely related index to benchmark your Large Cap Fund.

Today, when people reference “How’s the Market”, they mean how is the S&P 500 doing.

If you own a Mid-Cap Fund, one Index you can compare your Fund to is the Wilshire US Mid-Cap Index.

If you own a Small-Cap Fund, one Index you can compare your Fund to is the Russell 2000.


Come back next week for Part 2 of this post, the conclusion to How to choose a Mutual Fund.

Welcome to the Nerdery,