The Seven Factors I Use When Making A Decision About A Mutual Fund

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So how do I pick the funds that I invest in? Although I don’t prescribe this list for everyone, I use seven distinct factors for selcting the funds that I plan to invest in. These factors usually tell me everything I need to know about the fund and whether or not it’s a good choice for me to put my money there. These factors are (in no particular order):

The expense ratio The lower, the better. This is actually the biggest factor I look at, though not enough to swing me into investing in a fund with truly poor recent returns. Why? A fund with a low expense ratio is one that is looking for efficiency in investing, because many people merely look at returns. This means that when the market is bad and the actively managed and expensive fund is struggling, the efficient fund will have less baggage. You can find this info on the Morningstar.com page for the fund.

The five year return I basically view five year returns as the real short term, as I’m not in a mutual fund looking to maximize single year growth. Usually, a five year trend shows you most of one economic cycle, so you can get a rough idea of how it’s doing given the recent path of the economy. You can find this info on the Morningstar.com page for the fund.

The ten year return On the other hand, I also like the ten year return, which shows how it did over a full economic cycle (and a bit more). It shows me whether or not the five year trend is a fluke – if the two are far apart, I need to do some research before I invest. You can find this info on the Morningstar.com page for the fund.

The Morningstar rating I place a lot of trust in Morningstar’s rating, and I usually find it to be a nice thumbnail sketch of the state of the fund. I discussed this one in detail yesterday. You can find this info on the Morningstar.com page for the fund.

The investment philosophy of the fund I like to understand the ideology behind the fund: why do they invest the way they do? I like funds that primarily are on the lookout for shareholder value, but you may have different things you’re looking for (“green” investments and the like). You can find this in the fund’s prospectus, usually available from the investment house.

The turnover The lower, the better. High turnover funds might get nice returns, but they also hammer you hard on taxes. A high turnover usually the sign of a frenetically managed fund. You can find this info on the Morningstar.com page for the fund.

All other fees Before I make the leap, I make sure that there are no other fees or expenses that are hidden from my eyes. I do this by giving the site of the investment house a very thorough scouring for such things before I put in my money. I was literally obsessed with Vanguard for a period before finally investing with them. You can find this information on the website of the firm you invest with.

It’s also worthwhile to check out the full mutual fund prospectus before you invest, just to get a broader view of things. I previously wrote a guide to reading a mutual fund prospectus if the task seems daunting.

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2 thoughts on “The Seven Factors I Use When Making A Decision About A Mutual Fund

  1. typo:
    The expense ratio The lower, the better. This is actually the biggest factor I look at, though not enough to swing me into investing in a fund with truly poor recent returns. Why? A fund with a low expense ratio is one that

    yes??

  2. Can you also post the steps that you take before investing in individual stocks.

    BTW…recently started reading your blog and I’m learning so much.

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