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Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Thursday, February 25, 2010

Tips on Picking a Mutual Fund – Part II

In our last post, we discussed some of the basic factors for do-it-yourself investors to consider when picking no load, no-transaction-fee mutual funds for their portfolios. Included were the Morningstar® rating, category and style classifications, fund expense ratio and category ranking. While consideration of those factors provides a good start in selecting a good fund, there are many other criteria that need to be considered.

This post will focus on some but not all of the things we consider when picking our recommended funds. Many of the fund characteristics discussed below can be found free-of–charge on Morningstar’s web site. Some however, require subscription to Morningstar’s premium online service. Below are some additional things we believe you should consider when picking a fund:

Fund Inception Date:
Generally, we like funds that have been around for five or more years with a proven track record. For us, consistency in performance is very important.

Management Tenure: A fund with a new manager raises question marks. Will the new manager be able to continue the fund’s good performance? How experienced is the new manager? We prefer funds whose management has been in place for at least three or four years, preferably longer. Funds with management teams can provide a smooth transition when one manager moves on.

Portfolio Composition: It’s a good idea to look a bit deeper to see what the fund really invests in. A large allocation to a particular sector could be a red flag. The management team may be trying to time the market – a tough thing to do. Is the fund investing significantly outside of its category and style classifications? It’s not unusual to see domestic stock funds investing in international stocks in an effort to juice returns. When funds stray from their stated category and style, it can make it difficult for you to maintain your target allocation and risk tolerance.

Net Assets:
We try to avoid very large funds (except in the case of index funds) since it can be more difficult for large funds to find attractive investments consistent with their style and category. On the other hand, very large funds have an opportunity to spread their fixed costs over a bigger portfolio, making it easier to lower their expense ratio.

Consistency of Performance: Look at a fund’s performance over the last five to ten years. Has it been relatively consistent, or does it swing wildly from year to year. Funds with very inconsistent performance may be trying unsuccessfully to time various market sectors. We prefer the more consistent performers. Nevertheless, don’t let one bad year necessarily scare you away. Most funds tend to have a bad year in their lifetime.

Stewardship Grade: Unfortunately, only a limited number of funds have been assigned a Morningstar stewardship grade (from A-best to F-worst). The grade is based on five components including the Corporate Culture, Board Quality and Management Incentives. A good stewardship grade helps you pick funds that, on the surface at least, seem to focus on investors’ best interests.

Analyst Reports: Not all funds have a Morningstar Analyst assigned to them. For those that do, you can get a better insight into how a fund is doing and how well it is being managed.

Picking a good mutual fund that will perform consistently during good and bad markets is difficult to do. There are many other factors we haven’t discussed. In many ways, picking a solid mutual fund is more art than science. Hopefully, we’ve provided a few guidelines to help the do-it-yourself investor pick funds that will serve them well through good times and bad.


Anonymous nri mutual fund said...

Nice Blog. :)

May 18, 2010 at 2:33 AM 

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