Inveterate fund geek that I am, I have a strong bias toward the investment option of choice for more than 90 million of us -- one that no less an authority than Jack Bogle has called the "finest vehicle for long-term investing ever designed." Among other things, if you're after smart diversification and access to asset classes that might otherwise elude you, mutual funds should be your very first stop.
If, for example, you want to anchor your portfolio with mega caps such as Nokia (NYSE: NOK ) , Pfizer (NYSE: PFE ) , Wal-Mart (NYSE: WMT ) , and JPMorgan Chase (NYSE: JPM ) , funds provide a no-muss, no-fuss solution. Even better, once that foundation is in place, you can look down the market's cap range to racier companies such as DirecTV (NYSE: DTV ) and Adobe (Nasdaq: ADBE ) . Once you're all set on the domestic equity side, funds allow you to tread into waters -- such as emerging markets and high-yield debt -- that (just making a wild guess here) you're probably a bit less familiar with than domestic stocks.
Put it together, and what do you have? A well-rounded, growth-oriented portfolio that can help you beat the market over time while keeping a lid on pesky volatility -- provided, of course, that you know how to separate the fund industry's wheat from its plentiful chaff.
Aye, there's the rub
Alas, the vast majority of funds are overpriced laggards, duds that lack proven management teams, long-haul track records of success, and strategies that allow their stock-pickers-in-chief to take advantage of up markets and down. What's more, with more than 7,000 funds to choose from, the odds of throwing a dart and hitting a winner come in two flavors: slim and none.
Good thing we don't believe in dart-throwing. Since the advent of our Champion Funds newsletter service, our thesis has been that if you ask and answer a consistent set of questions, you can home in on the industry's best and brightest. In the process, you'll leave your friendly neighborhood stock jock in the dust, where he'll be crying over his outsized brokerage bill.
Free for all
Fund investing is commission-free if you go directly through the shop that offers the fund. And if you prefer the convenience of keeping all your money under one roof -- and consolidated quarterly statements, too -- not to worry: Most of the major brokerages maintain lists of no-transaction-fee (NTF) funds, which you can snag without paying a commission.
Alas, a commission-free dud remains, well, a dud. As you go fund shopping, then, put these two traits near the top of your list:
1. A manager with a successful track record of at least five years
Lots of otherwise savvy folks get hung up on a fund's past performance, but if a seemingly impressive track record doesn't belong to the manager who's currently calling the shots, that showing -- in the immortal words of Elvis Costello -- means less than zero.
It's the manager's performance you should focus on, not that of the fund itself, and while there are a handful of exceptions, five years is just about the minimum amount of time that managers need to weather at least one market cycle -- and to show that they have the right stuff.
2. A reasonable expense ratio
Even if you do bypass a brokerage commission, you'll still have to pony up for a fund's expense ratio. All things being equal, the lower it is, the better. But before you assume that you should invest in a low-cost index tracker such as Vanguard 500 Index (VFINX), remember that with index funds, the most you can realistically expect is to underperform the market each year by about the amount of your annual expenses.
While index funds certainly have their place (just ask Jack Bogle!), I believe on-the-ball investors should shoot higher without paying for the privilege. With that in mind, consider that while the typical domestic stock fund will ding you roughly 1.4% each year, those we've recommended in Champion Funds cost around 1% on average. Considering that 96% of our picks have made money for shareholders -- and that, as a group, they're beating the market as well -- that's quite a deal.
Smart fund investors should consider lots of factors before taking the plunge, but for my money, the manager's track record and the fund's price tag are two critical pieces of the puzzle. If you'd like to sneak a peek at how to assemble the whole shebang, click here to check out the latest installment of Champion Funds.
This article was originally published on Sept. 14, 2006. It has been updated.
Shannon Zimmerman runs point on the Fool's Champion Funds newsletter service, and he didn't own any of the securities mentioned above at the time of publication. Wal-Mart and Pfizer are Inside Value picks. JPMorgan is an Income Investor selection. You can check out the Fool's strict disclosure policy by clicking right here.