Once the foundation of your overall financial plan is built (bills up to date or debt-free, 3-6 months cash in the bank, and a working budget so you know how much you can afford each month) it’s time to pick a fund!
First, do you understand what a mutual fund is? Essentially, a mutual fund is a formal investment partnership. The fund manager decides what financial vehicles his or her fund will invest in, and then investors buy shares in the fund if they’re convinced that the manager’s goals are in line with their own.
Mutual funds can include collections of stocks, bonds, commercial notes, and many other financial issues traded in our economy. Investors should understand what they are investing in, and the risks associated with buying shares in a mutual fund. Don’t just look at the average return, look at the fluctuations in value over long periods of time.
Stock mutual funds are also very different. Some trade in a particular sector of the economy, like energy or industrial production. Others trade in a broad range of stocks that divide the markets by company size. Still others buy portions of virtually the entire stock exchange. These are called “index” funds. These funds often have low expenses because the fund managers don’t have to do any research or analysis of the stocks they select–they buy everything!
So, how do you pick a winning mutual fund? I recommend that you start by setting up a money market mutual fund at a low cost brokerage firm. I chose Schwab 20 years ago, and while they aren’t the least expensive, I’ve always appreciated their level of service and support. Many companies will let you open accounts with very low costs as long as you allow a certain minimum to be withdrawn from your traditional bank account periodically.
Once you have opened your account, use the company’s research materials to educate yourself on your choices. You can also use Yahoo! Finance to begin your learning. Yahoo!’s tools are very easy to use and give you access to information that was only available to brokers just a few years ago.
Cash should be piling up in your brokerage account while you continue your research. This is helpful because many funds require you to open a new account with at least $1000. There are exceptions, however. My quick review of the Yahoo! mutual fund screener of US stock funds with no minimum investment and no load (or sales) fee turned up 8 funds. These were:
CNGIX CNI Charter Large Cap Growth Eq Inst
CNLIX CNI Charter Large Cap Value Eq Inst
NMPAX Columbia Mid Cap Index Z
WGICX Credit Suisse Trust Large Cap Value
DFMVX DFA Tax-Managed U.S. Marketwide Value II
GSMCX Goldman Sachs Mid Cap Value Instl
JGLTX Janus Aspen Global Technology Instl
VPGRX Vantagepoint Growth
Next, I take a look at the track record of the funds I’ve found. I’m looking for funds with a 5 year track record under the same manager (for an actively traded fund.) Then I compare that fund’s results against the benchmark exchange traded fund in the same segment of the market.
Here’s an example: Take the Dimensional Fund Advisors‘ product, listed above (DFMVX). It’s manager, Robert Deere, has been with DFA since 1991 and managed this fund since 1998. The fund cost are very low (.28%) compared to others in this sector. Compared with the Dow Jones’ Industrial average, this fund has outperformed the average over five year, but underperformed in during the last 12 months. Since I take a 5 year (or longer) this fund would pass all my requisites for further consideration.
Once you have a short list of funds, you can look at more practical considerations. Is this fund in a large family of funds so you can easily branch out later, or is it only available through a broker? How responsive is the fund to phone inquiries? In short, is the fund easy to open and easy to work with?
For me, I’ve found that using Schwab’s fund selection tools, and limiting my choices to funds that offer no sales charges or transaction fees, I quickly arrive at a manageable list of choices.
If this process sounds complicated, it is only because of the extensive list of choices available to us today. It’s tougher to invest in a mutual fund than it is to buy a car because there are so many fewer car options!
I believe, however, that fear prevents many potential investors from picking their first fund. Once you make that leap, you’ll understand the process and continue a lifetime of investment.