Six thousand, eight hundred and twelve. No, it's not the number of times you've heard [insert overhyped celebrity's name here] mentioned in the media in the past week. According to Morningstar, it's the current number of open-end mutual funds and ETFs currently available to the investing public -- and that's not even counting multiple share classes! Yes, that's almost 7,000 funds through which investors must wade to find the few that deserve their investment dollars.
"But I have a day job!" you cry. "How can I possibly finagle enough time out of my hectic schedule to find these proverbial needles in the haystack of funds?"
Fear not, Foolish fund investor. I'm here to help you cut through some of the chaff. I've got common-sense guidance about what questions to ask, and what to look for, when taking stock of a mutual fund. (Pun intended!)
Does the fund do what it says it will?
This may seem obvious, but you'd be surprised how often fund management strays from its stated mandate. If the fund bills itself as a small-cap stock fund, it's important to see management investing in legitimate small-cap companies. Many small-cap funds, especially those lucky or talented enough to rack up some good returns and a fair amount of name recognition, get flooded with inflows, as investors seek to hop on its recent hot performance.
For small-cap funds, this can be a curse in disguise, making it increasingly difficult for management to invest its ever-increasing asset base in smaller-sized companies. Many small-cap funds' holdings suffer an upward drift in their average market cap, and an increase in allocation to mid-cap or even large-cap securities.
Likewise, if you are investing in the ABC U.S. Blue Chip Domestic Equity Fund, you don't want to find small-cap foreign holdings alongside your GM
How long has the fund been in existence?
Beware funds without established track records. Many smart investors advise you to look for funds with at least a five-year track record; that's typically enough time to assess a fund's long-term potential. But I wouldn't consider five years the only hurdle a fund must clear before it's worth your consideration. You should also see how the fund performs in positive and negative environments, so you'll know what to expect in all types of conditions. Going back five years from today would only cover the last several months of the 2002 bear market. A fund that weathered the entire bear market from 2000 onward, and the subsequent recovery, deserves a greater vote of confidence.
How long has the current manager or management team been at the helm?
In the late 1990s bull market, a multitude of funds opened in response to investor demand. Many featured inexperienced management teams, since prevailing wisdom at the time held that anyone could make money, regardless of experience or academic knowledge. During the subsequent bear market, many of these same funds closed and faded away into obscurity, hammered by heavy losses and asset outflows.
In truth, money managers need to have a long-term track record of consistently managing assets in good and bad environments alike. Check how long the manager or management team has been in place at a fund before buying. Ideally, you want to see a long-tenured management structure, increasing the likelihood that the fund's past track record will indicate its future performance.
How expensive is the fund, compared to its peers?
In investing, many factors lie beyond your control. But Foolish investors can definitely choose how much they'll pay for their mutual funds. Too many funds charge excessive fees for mediocre performance, and they simply aren't worth your time. Look carefully at a fund's expenses, and understand how much of your investment returns will be going to the fund company instead. Get an idea of what the average fund costs in each category, then see where your fund falls in that range. If it's significantly above average, move on. Chances are, another fund out there can do the same job at a lower cost.
Saving the best for last
Look at an individual fund's performance only after you've answered all these other questions. Too often, investors look first for funds with the highest recent returns, then perform due diligence only on funds at the top of that list. I'd suggest that performance be the last thing Foolish investors look at. Sure, you need to know how a fund has performed compared to its own track record, its benchmark, and its peers. But that should be one of the last pieces of the puzzle, not the first.
Of course, this list can't cover every nuance of the many funds available to investors today. But keeping these points in mind will give any Fool the upper hand in identifying those rare funds worth your time and money. Compared to keeping track of the latest tabloid scandal, at least it'll be time well spent.
For more Foolish advice on finding the mutual fund needle in the haystack, take a look at our Champion Funds newsletter service. TMF fund expert Shannon Zimmerman zeroes in on the best mutual funds, saving you a whole lot of time and effort. Check it out for free with a 30-day trial.
Fool contributor Amanda Kish lives in Rochester, N.Y., and hopes she lives to see the day when either the Buffalo Bills win the Super Bowl or the Buffalo Sabres take the Stanley Cup. She's not greedy -- one or the other will suffice. Amanda doesn't own shares of any of the companies mentioned here. She welcomes your feedback at firstname.lastname@example.org. Coca-Cola and Wal-Mart are Inside Value picks. The Fool has a disclosure policy.