Before you choose a mutual fund you need to decide what type of funds you are going to invest in. You will need to decide what percentage of each asset class you want to invest in. This article is not about coming up with an asset allocation but it is about selecting the right funds for you when you have decided on your asset allocation.
One way of bypassing this whole process is to get a target date retirement fund. One such fund is the Fidelity 2030 fund. If you are unwilling to spend a lot of time researching this type of fund may be best for you. This type of fund allocates moneys based on your retirement date. I am not a big fan of these funds because they allocate money based on one criteria your retirement date. Most investors have other goals, and risk preferences. Most of these target date funds use funds from their own family. That means all of the funds use the same research and follow the same investment guidelines. In general fund companies do better in some asset classes than others.
So how do I go about selecting the best mutual fund? There are two philosophies on selecting mutual funds. One is the low cost index fund crowd. It is a known fact that 80% of the mutual funds underperformer the index they are measured against. By using an index fund you are locked into performing as well as an index. Should you be in a 401K or 403B with limited choices, I think that index funds are the way to go particularly with domestic stock funds. When it comes to Small cap, Micro cap, Global funds and particularly emerging market funds index funds are not the way to go.
So let's assume you have a self directed IRA with one of the big mutual fund companies where you have thousands of funds to choose from. To select the best mutual fund there are many websites including but not limited to fund picks from Fidelity or Morningstar. I am a big fan of the fund picks from Fidelity. I really like the ones which are not Fidelity funds. Face it Fidelity is going to plug their funds. Many of the fund picks from Fidelity that are Fidelity are also very good choices.
I want a fund manager with at leas 5 years running the fund. If they have beaten the market the last 5 years chances are they will beat the market again this year.
Investigate to see how the fund has performed in bad markets. Do the same for good markets as well. There are a number of tools on the internet to perform this function. I prefer Yahoo historical data. Pick a time when the market was down and compare it against the fund. Do the same in up markets. A word of caution here sometimes the funds pay dividends and the chart or data table you may be using may not take that into account. You will find some funds do worse than the market in bad markets and better in good markets. Most balanced funds will do better in down markets and not as well in up markets. A fund that drops slightly faster in a bad market than the market but far out performers the market on the way up is an excellent fund. Likewise a fund that drops less than the market during a downturn and keeps up with the market on an upturn is also an excellent fund.
I avoid funds that invest with a political or religious bias. Often these funds are sometimes called social funds. They can put severe restrictions on what the manager can do with the fund. If you choose to invest in this manner I respect your conviction but be advised fund performance may suffer.
The best mutual funds are going to mean more return on your investment.