Money Bucket Of Cash Bills

Mutual fund managers pool their investors' money and invest it according to their strategy. Image source: Getty Images.

This article was updated on June 8, 2016, and originally published on Jan. 27, 2016.  

If you've been meaning to pay more attention to your personal finances and invest in very promising mutual funds, then read on. Here are some tips that can help you zero in on the best mutual funds.

Seek low fees

First off, seek low fees, because even seemingly small differences can make a difference of tens of thousands of dollars. Imagine, for example, two equally compelling mutual funds, one of which sports an "expense ratio" (essentially its annual fee) of 0.60%, while the other charges 1.60%. If you invest $10,000 in each and they both grow by 10% annually, in 20 years, the first one will leave you with about $60,300, while the second holding will be worth $50,200 -- more than $10,000 less!

What kind of fees are reasonable, then? Well, you can find many index funds that passively track various stock indexes charging just 0.25% or less and among all stock funds, the average expense ratio in 2015 was 1.31%.Here are the average fees of several different kinds of funds as of 2015, according to the Investment Company Institute and Lipper:

Fund Type

Average Expense Ratio, 2015

Growth stock

1.26%

Sector stock

1.40%

Value stock

1.23%

Blended stock

1.09%

World stock

1.42%

Hybrid

1.34%

Bond, taxable

0.98%

Bond, municipal

0.93%

Target date

0.94%

Index equity fund

0.71%

Seek low turnover

Another promising characteristic of a mutual fund is low turnover -- which means the fund isn't buying and selling frequently. A turnover ratio of 100% reflects a fund with a total annual trading volume equal to its overall size. In other words, it turns over the value of its holdings about once a year, on average. Index funds will have very low turnover ratios -- typically 0.10% or less -- because they just track indexes, the composition of which doesn't change every day. In general, a low turnover ratio, such as 0.50% or less, is better than a higher one -- though it's just one of many factors to consider. It suggests that a fund's managers are patient and confident in their holdings.

Seek strong performance

One of the first things that many investors look for in a fund is a strong performance record. That's reasonable, but assess a fund's record carefully. For example, it's good not only to check out, say, its 10-year average annual return but to also try to view each of those years' results. Why? Well, because there might have been an extremely strong or weak performance that pushed the average up or down significantly. That might not be a dealbreaker, but it's good to be aware of.

Also, compare the fund's performance to its benchmark, such as the S&P 500 for large-cap-oriented funds or the Russell 2000 index for small-cap funds. A five-year annual average of 6% may not seem exciting unless you see that the benchmark averaged just 3.7% in the same period.

Or just stick with index funds

Finally, remember that if it seems like a lot of work to find, invest in, and then keep an eye on a handful of promising mutual funds, you can just opt to invest in index funds instead. The respected Vanguard 500 Index Fund (NASDAQMUTFUND:VFINX), for example, is an index fund based on the S&P 500, holding some $229.2 billion in assets and sporting a low expense ratio of 0.16%. The SPDR S&P 500 ETF (NYSEMKT:SPY) charges even less -- just 0.09%.

Some candidates to consider

Here are a few mutual funds you might want to consider. Each sports a relatively low expense ratio, no load, an above-average track record, and five stars from the fund-watching folks at Morningstar:

Fund

Category

Expense Ratio

10-Year Avg. Annual Return

Vanguard Dividend Growth (NASDAQMUTFUND:VDIGX)

Large-cap blend

0.33%

8.7%

Buffalo Discovery (NASDAQMUTFUND:BUFTX)

Mid-cap growth

1.01%

10.5%

T. Rowe Price Diversified Small-Cap Growth (NASDAQMUTFUND:PRDSX)

Small-cap growth

0.82%

8.09% 

 
  • The Vanguard Dividend Growth fund features a low expense ratio, a relatively low turnover ratio of 26%, and an investing style open to both "growth" and "value" holdings. It also offers a dividend payout that recently yielded about 1.9%. It has outperformed the S&P 500 over the past 10 and 15 years.

  • The Buffalo Discovery fund has a higher turnover ratio, of 52%, which is a little lower than average. Its expense ratio is close to average, but its performance isn't, as it has outperformed the S&P 500 over the past three, 10, and 15 years. It's strongly focused on growth stocks, favoring mid-sized ones.

  • The T. Rowe Price Diversified Small-Cap Growth fund has a low expense ratio and a low turnover ratio, too, of 4.3%. Over the past three, 10, and 15 years, it outperformed the S&P 500. Nearly half its holdings were recently in industrials, technology, consumer discretionary, and healthcare.

Mutual funds offer a great way to be invested in lots of promising stocks or other assets in a single stroke. Just choose any fund carefully.

Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, owns no shares of any company mentioned in this article. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.