Mutual funds are excellent investment choices for many individuals to help them achieve their financial goals and attain investment success. Mutual funds are excellent investment vehicles, however one must keep in mind that they are no guarantees when it comes to investing. Investing requires individuals to take risk, and be exposed to potential volatility with their investments. But, with the right knowledge and a good set of criteria in selecting your funds, you can build a great foundation for you financial plan, investment portfolio, and increase your odds at attaining investing success. Here I address a few key items you need to include in your research criteria for selecting your funds.

Investment Objectives of the Fund

What is the investment objective of the fund you are looking to buy? What strategy(s) are the fund going to employ, and what risks are involved? What will the fund invest in and how will it analyze what it buys or sells? These are all key factors that need to be assessed when choosing a fund. You need to be aware of how the fund will be managed and the risks that you will potentially be exposed to, allowing you to determine if the fund in question fits your personal goals and risk tolerance, whether individually or collectively within your investment portfolio. The fund’s investment policy and objectives are its basic set of rules or guidelines that will determine how the shareholders’ money is to be invested. You are diligent enough to establish your own goals, objectives and risk tolerance, and you owe it to yourself to understand how this fund will do the same with your money.

Fees and Commissions

Any fees and commissions you pay to buy, sell and hold any fund can and will have an impact on your overall rate of return earned on your investment. Holding all other factors constant, fees and expenses such as operating expenses will lower your overall rate of return. Therefore, this is a very important factor to consider when selecting a particular mutual fund. What types of fees and commissions might you pay when investing in a mutual fund?

  • Loads – Many of today’s mutual funds are no-load funds, which basically means they are commission free; no fees are paid and deducted from the amount you invest. Load can be front-end, meaning you pay them when you first buy into a fund, thereby reducing your initial amount invested, or back-end, in which the fee is paid upon redemption of your shares in the fund, reducing the net amount you receive upon the sale. Therefore, it is best to find a no-load fund that fits your objectives to avoid unnecessary fees and commissions.
    • Make sure you understand what share class you are purchasing. Mutual funds companies that normally charge a load will issue different share classes, typically labeled A, B, C, or D. There is no difference in how each share class is managed and invested – only the fee charged is different. Shares typically sold with a front-end load are classified as A Shares. B, C, and D share classes typically incur back-end loads or ongoing commissions such as 12b-1 fees.
    • Operating Expenses – Every mutual fund must charge fees to pay for the operational costs of running and managing the fund. These fees include paying the fund manager(s), paying the analysts conducting research for the managers, printing and mailing correspondence to investors, paying for necessary technology to manage the fund, etc.

If, in the event you do choose to purchase a share class of a fund that incurs sales charges, you should be aware that there are ways to effectively reduce the sales charge you will pay. Most funds will have they sales charge based on a breakpoint system, which basically means the more you invest with them, the lower your sales charge will likely be, and the money you invest will ultimately purchase you more shares. You can also use a letter of intent which details to the funds company your intent to invest a particular amount of money over a specified period of time to reach a certain breakpoint for the lower sales charge. Additionally, rights of accumulation can be used, which is basically using the appreciation of your investment for future investment purchases to save on future sales charges.

Assessing Performance and Risk

Performance of a fund is an important factor to assess when researching which funds you are likely to invest in, do not focus solely on past performance as an indication of its possible future returns. Just because a fund may have performed well in the past does not guarantee that same fund is well positioned to be successful in the future given the economic environment. Also, short term performance is a poor indicator for future long term performance. These numbers could be attributed to luck, and or skill, and may not tell you the whole story. The manager could have taken a perceived greater risk with a particular investment to achieve that excess short term return.

When looking at performance numbers, they don’t really tell the whole story without comparing them to a baseline, a benchmark. But make sure the proper benchmark is used to ensure you really understand how well the manager actually performed. There are dozens of indexes and fund category averages that measure various components of the market and help you assess the returns.

Make sure you also understand the investment objective of the fund and the risks the fund may be subject to. You need to be able to understand what the main goals are of the fund, how the fund plans on achieving these goals, and what risks they might encounter when trying to reach these goals. Your money is at risk, so you need to make sure you understand and are able to tolerate these risks. This information can be found in the fund’s prospectus, which is available by mail or online at the fund company’s website.

Who Is Your Fund Manager and Fund Family?

What fund family you choose to invest with should be an important factor when making your fund selection. Each fund family’s resources and capabilities will vary, and they will all have different levels of capabilities and levels of expertise for their different fund types. One fund family may specialize in index funds, whereas another fund family may be better suited at managing international funds.

In addition, you should have a fair understanding of who the fund’s manager, sometimes called the investment adviser. Detailed information can be found in the fund’s prospectus, and I highly recommend that you read it.