With so many mutual funds out there, companies loudly promoting their own funds, and people giving half-baked investment advice, how can we know what funds are really right for us? The best route is to take advantage of independent research, and for me, the best choice for independent research in mutual funds is Morningstar.

What is Morningstar? Morningstar is a provider of independent investment research in the United States and abroad. They provide much of this information for free at morningstar.com. Basically, you can use this site to look up independent evaluations on any mutual fund you like – and other investments, too. Morningstar is so trusted that many funds will use their ratings from Morningstar in their advertisements.

Okay, so how do I use it? Hop over to morningstar.com and enter the name of a mutual fund you want to look at. For our purposes, I’ll take a look at the Vanguard 500 (here’s the Morningstar page for that fund in a new window). The first thing you’ll see is a boatload of information about the fund – an almost overwhelming amount to a beginning investor. If you’re overwhelmed, click on the “Data Interpreter” link on the left hand menu, which will automatically explain some of the data for you. I used the “Data Interpreter” heavily when I was just getting started with funds.

Information overload! What’s really important? The biggest things to look at when evaluating a fund with Morningstar’s data is to look at the “Key Stats” box in the upper right. The big things that I look at are the Morningstar Rating (which I’ll discuss below) and the Expense Ratio (which I like to be low). I also look at the trailing returns in the Performance section, but mostly at the five year trend.

What do the stars mean? Each fund evaluated by Morningstar is given a star ranking, from one to five stars, that evaluates the fund in a nutshell. If you want to understand how these stars are generated, Morningstar provides a strong explanation of what they mean. Generally, I don’t spend much time looking at anything below three stars, but if it’s three stars or up, I’ll look at it more closely (as many conservative and index funds are given three stars).

One bad thing, though… As you start to really get into the information provided, you’ll find that some of the neat stuff you want to look at requires a premium membership. What I did was make a lengthy list of things I wanted to look at, signed up for a 14 day trial of the premium membership, looked those up, then cancelled the service. It was worthwhile information, but I simply did not want to pay that much for a service I wouldn’t use with high regularity.

In short, Morningstar is a great place to look up fundamental information about a fund that you might see in an ad or hear about from a friend. It provides the real scoop without any bias.

As an example of the mutual fund topics we’ve discussed thus far this week, I thought I would mention my exact mutual fund investments and how I plan to grow them in the near future.

First of all, I have two separate goals with my investments. The first is for buying a second home roughly fifteen years from now. Our first home, which we are in the process of buying, is going to be on the small side and both my wife and I want a larger home than the ones we are looking at so that we can have an invasion of grandchildren when we’re older. The second goal is an early retirement, targeting roughly twenty five to thirty years from now, so that I can be retired or very close to it when my grandchildren are born. These goals, as you can tell, have one big thing in common: family. My family is central to my life and thus my investments are geared toward them.

So, here’s my entire investment portfolio, using approximate numbers for values.

I have about $45,000 spread out between two separate 403(b) programs (for those unaware, 403(b)s are basically 401(k)s for people who work for a non-profit or for an educational institution). In both cases, this money is in that program’s version of the Vanguard Target Retirement 2040. When I establish my Roth IRA this year, I will be directly investing in that fund as well. Since my retirement goal is singular – I want to retire in roughly 2038 – I realized that I would basically be balancing my own fund with this retirement date as a target anyway, so why not just let them balance it for me? These funds have returned very well for me so far, and I anticipate watching them grow over time. I may make a small withdrawal from one of them, as it is allowed to aid with the purchase of a first home, but it will be less than 30% of the total amount I have in the funds.

As for that second house fund, I have about $5,000 in the Vanguard 500, which I selected because it is highly regarded, it has a very low expense ratio, it has a very long history of solid returns, and it is very easy to track and follow the holdings. I put in a specific amount each month that should have me on track to reach $10,000 in the account by the end of the year, at which point I will reduce my contributions. Why $10,000? It is a round target amount that puts me on a healthy pace, and at that dollar level, Vanguard eliminates a quarterly $2.50 fee on your balance.

Next year, I will complement this fund by buying into a much more aggressive fund, the Vanguard International Growth Fund. This one will basically determine how nice of a house we’ll buy when we’re 42. I feel strongly that globalization is just beginning, but I also feel that this is an event that can lift America’s boat if we place ourselves well – I intend to ride it a little.

Why Vanguard? In a nutshell, Vanguard treated me very well as a beginning investor and they have fund solutions for everything I want to do. I agree with their investment philosophies, their customer service is stellar, and I see no reason at all to jump to another investment house.

So, this is exactly where I stand in the middle of my twenty eighth year. Hopefully, a picture of one person’s real investments might give you an idea of what you could be doing with your money.

People ask me all the time if they should be putting some money into mutual funds, individual stocks, bonds, and so forth. Generally, I just ask them a few very simple questions and then give a simple answer that will set them down a path appropriate for their goals. Let’s walk through these questions and see where they lead you.

What is my goal with this money? If you’re thinking of investing money, you must have a vision for what you want to do with it. Do you want to buy your dream home in twenty years? Do you want to retire in five years? Do you want to quit your job in one year? Try to define a specific goal for the savings and also an approximate timeframe for that goal.

How far off is that goal? I generally sort people into three groups based on how far off the goal is: longer than ten years, one to ten years, and one year or less. If your goal is less than ten years, a mutual fund (especially one based in stocks) is probably not the best place to put the cash. If your goal is less than one year, I would actually leave it in cash and put it in a high-yield savings account.

Are you willing to devote a lot of regular time to your investment? For almost everyone, the answer is no, and if that’s the case mutual funds are probably the place to put your long term money. They take much of the time out of direct portfolio management.

As a general rule of thumb, the farther off your goals are, the riskier the mutual fund can be. If you’re looking at a forty year goal, having your money in things like an international small cap fund might be worthwhile because that fund could contain the next Microsoft, Cisco, and Google, but also might hold a Boo.com or two. However, if your goal is much closer (say, fifteen years), you probably want your cash in a relatively safe fund, like the Vanguard Total Market Index.

Earlier today, I discussed some of the basic benefits of mutual funds: simplicity, diversification, and solid returns. Of course, these benefits come with a price: there is no free lunch on Wall Street (or anywhere else).

Here are some of the most common expenses that are associated with mutual funds. As a thrifty investor, you’re going to want to avoid these expenses as much as possible, so I’m also giving some tips on how to avoid the fees or at least minimize them.

Turnover This refers to buying and selling that occurs within a fund. Not only do these have their own costs (such as brokerage fees), but they also eventually cost the holder of the fund capital gains tax on all of those exchanges. In short, a fund with a high turnover can be really expensive to maintain, even if on paper it appears as though the fund has great gains.

How to avoid it Look for funds with low turnover. If you can’t find information about turnover on the fund, ask. Usually, most index funds have extremely low turnover.

Management fees Funds have to have someone managing them, right? And management has some costs associated with it, right? This is the portion that pays for the people actually doing the work to keep the fund running.

How to avoid it Index funds generally have little management effort required (as they’re composed of a publicly available list), so they usually have a very low management cost associated with them.

12b-1 and other service fees Often, funds charge additional fees for such things as advertising (that’s what 12b-1 fees usually cover), legal fees, registration fees, accounting fees, and so on.

How to avoid it Look for discount brokerages (like Schwab, E*TRADE, or Ameritrade) rather than full-service brokerages, or deal directly with the fund group themselves (like with Vanguard at vanguard.com).

In other words, a great strategy for a beginning investor to minimize fees when they’re just getting their toes wet in mutual fund investing is to buy an index fund directly from a management company. In fact, that’s exactly what I do, and I’ll discuss my investment choices a bit tomorrow.

Recently, I received a lengthy email from a reader who had a ton of basic personal finance questions contained within. I thought it might be interesting to start an irregular “personal finance 101″ series to answer and explain some of her questions.

A mutual fund is an agreement between a large group of individuals to invest their money collectively in any number of things. Generally, this involves each member giving some amount of money to a fund manager, who takes their money and invests it for them. The proceeds from this investment, minus expenses, are then returned to the original investor.

What’s the point? I can invest money on my own. That’s true, and many people with a substantial amount of money to invest perhaps shouldn’t bother with mutual funds – they should have their own investment manager.

However, mutual funds offer one big advantage that a smaller individual investor can never have: they allow you to be diverse without investing a lot of money. For example, let’s say you have $1,000 to invest. It is extremely difficult to make that $1,000 be truly diverse without spending your time managing extremely tiny investments. Even if you stick with just stocks, you’ll be in a situation where either (a) all of your money is in one or two stocks, meaning you’re carrying a pretty healthy amount of risk, or (b) the amount you have in each stock is so small that transaction fees will eat basically all of your investment, leaving you with nothing.

A mutual fund, on the other hand, can take $1,000 from 1,000 people and have a million to invest. With a million dollars, a fund can invest in a wide variety of investments without being eaten alive with fees and such.

How do I get my money out? Most mutual funds exist as shares, meaning that you buy a share in a mutual fund for a certain amount of money. As the value of the fund goes up, so does the value of the share. When you decide it’s time to sell, you can sell the share on the open market or, quite often, back to the company managing the fund.

If you have additional questions about how mutual funds work in general, don’t hesitate to ask a question in the comments, and also stay tuned this week for much more information on mutual funds.