Consider This Before Buying

Buying a mutual fund without studying its top holdings is like buying a car without first checking under the hood. From the outside, the fund could look great, with a strong track record and promising manager. Still, savvy Fools will always take a closer look at the fund's top stocks before investing, just to make sure they aren't buying a lemon.

This extra research can be a daunting process. It becomes impractical with funds that hold hundreds of stocks. Yet even so-called "focus" funds, with only a handful of stock holdings, still require you to carefully research 20 or 30 stocks. Few people have the time or knowledge to complete a task like that. That's where Motley Fool CAPS and its community of more than 105,000 investors can help.

Pray tell ...
Every week, we'll look at one of this year's hottest funds, and see what Main Street investors have to say about its top picks. We'll pay particularly close attention to funds that put a lot of weight in their top 10 holdings.

This week, we're taking a closer look at the Vanguard REIT Index (VGSIX). The fund lost 17% in 2007, while the S&P 500 gained 3.5%, but it's since rebounded; it's up 7.6% year to date. It has been run by the same manager, Gerard C. O'Reilly, since May 1996, and it offers a 4.6% yield and a microscopic 0.20% expense ratio. This REIT index has also done extremely well during O'Reilly's tenure, averaging 11.5% annualized returns over the past 10 years. But what about the future? Let's see what CAPS players think about some of the individual stocks.

Holdings as of March 31 from Morningstar.com and Motley Fool CAPS.

As you can see, the Vanguard REIT Index is wagering about 42% of its assets on these top 10 picks. Because the fund's turnover ratio is a relatively small 36%, meaning the average holding time is approximately three years, it's important for investors in a fund like this to feel every bit as confident in the selections as in the manager who's making the calls. Unfortunately, CAPS investors don't seem to think these picks are very good -- only two stocks receive more than two stars from our community.

That's important, because in our first year of collecting CAPS data, we saw that four- and five-star-rated CAPS stocks tended to handily outperform the market, while one- and two-star stocks have underperformed. Based on that measure, then, this fund could be making some worrisome bets. Then again, the investing community may be taking a "once bitten, twice shy" approach to real estate stocks, and it could be missing the big picture.

What do you think about these stocks -- or any stocks, for that matter? Make your voice heard among those of 105,000 other investors on Motley Fool CAPS. Just sign up today, and start rating your favorite stocks. You can even check out the holdings of your favorite funds to see how they stack up. Why not? CAPS is 100% free.