This is part two of my What To Look For in Mutual Funds post. You can (and really need to) read part 1 here.
Yesterday we examined the evils of loads, expenses, and other fees that mutual funds charge. Today, we will look at two other areas often overlooked when choosing a mutual fund.
Turnover is a measurement of how long a mutual fund holds the stocks it buys. So, if you see a fund with a turnover of 100%, that is telling you it basically sells out of all of the stocks it invests in each year and buys new stocks. You may be thinking how does this impact you? Well, it impacts you because each time the fund buys or sells stock, there is a transaction fee the fund is charged. I hope you don’t think that the fund simply eats that cost, because it doesn’t. It passes it through to you, the shareholder. As a side note, there are funds out there that have turnover over 200%! It’s not surprising that the management fee on these funds is sky high. On the opposing end are index funds, whose turnover is close to zero.
I realize I told you earlier that past performance is no guarantee of future performance. It’s not. But you can use past performance to gain some insight into the fund. You’ll want to look at the annual returns for the past 10 years. How did the fund do each year? Was it fairly consistent or did it get crushed during down markets and rose exponentially during up markets? Look for consistency. It may not sound fun to invest in a steady performer, but you’ll be thankful for it when the market drops and your fund is riding out the storm.
- Never pay a load on a fund. Realize that even if you have a found the greatest fund of all time and it charges a 5.75% load, your fund has to return more than 5.75% just to beat the market. If your fund returned 10% and the market returns 8%, the market was the better performer.
- Never, ever, ever, pay a contingent deferred sales load (CDSL). It is simply a way to get around calling a fund a front load fund. In many cases, it is actually worse. If there are fees and rules for buying and selling and it confuses you, you are better off not investing in that fund.
- Watch expense ratios. The lower the better. Check out Vanguard, Fidelity or T Rowe Price for funds with low expense ratios. If you cannot afford those fund minimums, look into Schwab funds through Charles Schwab or investing through Sharebuilder (See my review of Sharebuilder) for other low cost mutual funds.
- Be aware of fund turnover. Find a consistent performer that does well both in good and bad markets. Remember, slow and steady wins the race!
If you have any questions, feel free to ask!