A Penny for Your Portfolio

Restaurants, shopping malls, car dealerships ... everywhere you look, there are people screaming for you to buy their products. And usually, the more you pay, the more you get. The Ferrari, for example, is much nicer than the Fiat. So that's the same philosophy you should follow with your portfolio, right?

Wrong.

When lending out your money in the form of a mutual fund, you should absolutely pay the least you can for your mutual fund manager. See, mutual funds are structured on an expense-ratio cost basis. So the lower your ratio is, the less money you're paying for performance. And while a low expense ratio is a hallmark of a high-quality mutual fund, there are a couple of other key metrics you should look for:

1. Management tenure.
2. Portfolio turnover.

These data points can show you how long a portfolio manager has weathered the market volatility storm and how often the companies in the fund are changed, respectively.

The performance trap
Now, so far I've ignored the data point that most mutual fund investors believe is absolutely the most important when choosing a mutual fund: past performance. Yes, performance matters. Let's get that out of the way. But contrary to popular belief, the recent best performers may not be the best funds for your money.

Just take a look at the following table, which shows the top-performing mutual funds over the past five years.

Those are some mind-blowing numbers. But how do these funds stack up on the other criteria?

You can see that the best performers might not always be the best for your money.

Take the ING fund, for example. A 43.8% five-year return is excellent, but you would have lost 8 percentage points of performance in the first year for fees.

What's more, the manager for the fund has been there since only 1999. Emerging markets have been pretty hot between then and now, and it's hard to know how this fund will cope if there's a prolonged slowdown in Russia.

Another factor to consider is that many of these funds are from recently hot (and cyclical) sectors such as precious metals. Evergreen Precious Metals might have performed well in the past, but we have no idea whether the manager will be competent to handle a turning of the tides. He's been there for half a year, and that doesn't provide for much of a track record either way.

Since past performance is by no means indicative of future returns, there's absolutely no guarantee that any of the funds above will continue to outperform their benchmarks. And with fairly high loads and expense ratios, investing in one of these hot funds right before the tide turns could cost you a lot of money.

So how does one find worthy funds?

Find good funds
Using a combination of the criteria above, low expenses, tenure, turnover, track record, and performance, Motley Fool Champion Funds advisor Shannon Zimmerman grades every fund in his universe for future investment-worthiness.

In the emerging-markets arena, he's tabbed Dodge & Cox International Stock (FUND:DODFX), which has returned 75.6% in a little more than two years. That amounts to 41.4% annually, comparable with the emerging-markets funds listed above. Dodge & Cox's current top holdings include Sony (NYSE:SNE), Vodafone (NYSE:VOD), News Corp. (NYSE:NWS), Nokia (NYSE:NOK), and PetroleoBrasileiro (NYSE:PBR), all of which have experienced price growth of at least 20% over the past year.

If you'd like to learn more about Shannon's service and his specific recommendations, look no further. His entire portfolio of superior, low-cost funds is beating the market by almost 9 percentage points.

And remember that while you may not get the best car for the least money, you will get the best mutual fund.

Fool sector head Shruti Basavaraj owns a huge piggy bank full of pennies, but not one share of any companies mentioned above. Vodafone is an Inside Value recommendation. The Motley Fool has a disclosure policy.