Can Your Portfolio Compete?

Every February, college football's elite players gather in Indianapolis for the NFL scouting combine. These players are poked, prodded, measured, timed, and tested in a series of mental and physical drills. NFL coaches and general managers scrutinize every nuance of a player's performance to evaluate his pro potential: Is his vertical jump up to snuff? Can his footwork be fixed? Is his favorite musical group really Coldplay? (For Chicago Bears quarterback Rex Grossman, the answers are sadly no, no, and yes.)

Welcome to the mutual fund combine
As general manager of your portfolio, you can analyze a few key stats to find the mutual funds most likely to beat the market. Since approximately 75% of actively managed funds lose to their benchmark index, you'd better know how to separate the studs from the duds. So grab a whistle and a stopwatch -- these five drills will put your portfolio to the test.

1. What a load.
A load is a sales charge that some mutual funds use to pay brokerage costs. This fee is essentially a fund manager's way of stealing your money and spitting in your face. If you own shares in a fund that charges a load fee, you might look into either transferring your assets into a no-load fund immediately or investing in a nice handkerchief.

2. Spare the expense.
Unfortunately, there's no such thing as a free lunch, even at a no-load fund. A fund's expense ratio covers management fees and administrative costs. The average expense ratio is around 1.5% of assets, but a shareholder-friendly shop like Vanguard typically charges a fraction of this amount. When it comes to expenses, the lower the better: Every percentage point you pay is coming straight out of your returns.

And don't overlook the 12b-1 fee, which covers the fund's marketing and advertising expenses. Don't invest in any fund that charges a 12b-1 fee, unless you really enjoy watching your fund family's TV commercials.

3. Are you experienced?
Check the fund manager's performance history: Has she been managing money for decades, or are you paying the price while she cuts her teeth? Great skippers, like Third Avenue's Marty Whitman, have been honing their skills through both bull and bear markets.

A quick Google search should tell you everything you need to know about your fund manager's relevant experience and investing philosophy. And if the only hit your search turns up is your manager's MySpace page? Leave him a comment to let him know you're selling your shares.

4. Put your money where your mouth is.
Does your fund manager eat his own cooking? The strongest sign that a manager's interests are aligned with shareholders is a whopping chunk of his own cash invested in the fund. You can see your manager's stake in the "Statement of Additional Information," available on the fund company's website.

5. Turnover a new leaf.
The turnover ratio measures how often the fund manager jumps in and out of holdings. A larger number generally translates into a higher tax bill each April, so as with the expense ratio, lower is better. However, don't be afraid to hold high-turnover funds in a tax-favored account, such as an IRA, 401(k), or 403(b).

Past performance is not an indication of future results
Astute readers will surely notice that I omitted the most popular metric for evaluating mutual funds: The total returns that the fund posted in previous periods. As my Foolish friend and Motley Fool Champion Funds advisor Shannon Zimmerman will tell you, a fund's past performance is only relevant to the extent that it captures the record of the current fund manager.

A quick scrimmage
Let's see how the largest mutual fund in the United States, American Funds Growth Fund of America (AGTHX), performs in our five drills. The fund's 5.75% front load is an immediate red flag, as is the 0.25% 12b-1 fee. However, the fund's 0.63% expense ratio is far below that charged by its average competitor.

Growth Fund employs 10 managers, each responsible for a portion of the fund's portfolio. These managers are both seasoned (an average of 26.5 years in the industry) and heavily invested in the fund (eight of the managers own at least $500,000 worth of shares). And the fund's turnover ratio is extremely low, at just 22%. Here are Growth Fund's top holdings as of Jan. 31:

The fund's managers have performed admirably in a tough environment for large-cap growth stocks, but I wouldn't expect to see Growth Fund added to our Championship roster anytime soon. It's hard enough to beat the market without 6% in superfluous fees weighing down returns.

Speaking of returns ...
Shannon uses these five stats (and his years of experience as a Morningstar analyst) to determine which funds are worthy of Champ status. To date, a full 83% of his recommendations are beating their benchmark index. Click here to take a 30-day risk-free trial of the Fool's Champion Funds service -- just in time for the March issue, where Shannon starts his annual review of the performance of all his Champs.

Although he has an emotional investment in the performance of the Chicago Bears, Rich Greifner does not own shares in any of the securities mentioned in this article. Microsoft is an Inside Value recommendation. The Motley Fool has a disclosure policy.