If you read the appendix on mutual funds in The Motley Fool Million Dollar Portfolio, you know there are a lot of bad funds out there. But there are also some great ones, and this worksheet is designed to help you find them.
Step 1: Identify 10-12 funds you want to check out.
If you’re investing through a company 401(k) plan, you can get a list of your fund choices from your plan administrator or HR. I
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Step 2: Has the manager been at the helm for at least five years?
Remember, when you’re investing in a fund, above all else, you’re investing in its manager. If the manager is new on the job, it’s difficult to judge his or her performance. That’s why we look for a manager who has been in the role for five years or more. Morningstar is a wonderful resource for mutual fund data. To find out how long a fund’s manager has been there, type the fund’s ticker symbol in the Quotes box at the top of Morningstar.com, then click go. Look for “Management” on the left-hand side of the page. That link will take you to a page with some good information on the manager, including his name, start date, a brief bio. Cross off any funds whose manager hasn’t been there at least five years.
Step 3: Has the fund beat its benchmark by at least 1% annually for the past five years?
To find this, just click the back arrow or type the fund ticker into the Quotes box again. You’ll see a small chart with the fund’s performance over the past five years. Underneath, you’ll see the fund’s returns for each of those years as well as whether (and by how much) it beat or lost to the S&P 500 and the other funds in its category. Look for that’s beating those benchmarks (preferably at least +1%). Eliminate those that haven’t.
Step 4: Is the fund’s expense ratio 1% or less?
Stay on the same page to find the fund’s expense ratio. It’s next to the chart under Key Stats. The expense ratio is the percentage of your money that goes to pay the manager, the fund company’s rent, and other costs of running the fund. Since that’s money you’re not earning a return on, you want to make sure this number is as low as possible. Any fund with an expense ration of 1% or less can stay on the list.
Step 5: Does the fund carry a load?
In addition to the expense ratio, some funds charge loads. Avoid these at all costs! There is no reason to pay a load – you don’t get anything in return and load funds are no better on average than no-load funds. You’ll find the load fees right under the expense ratio. If they aren’t 0%, cross that fund off your list and move on to another fun.
Step 6: What is the fund’s alpha?
Alpha’s a tricky concept to explain, but as we put it in the book, “Here’s just about everything non-finance geeks need to know about alpha: If the figure in positive, the fund manager has likely added value. If it’s negative, he probably hasn’t.” So we’re looking for funds with a positive alpha. You can find this figure by clicking on the “Risk Measures” link on the right-hand side of the Morningstar quote page.
If you’re eager to dig even deeper, poke around on the fund’s website and do a Google search to read a little more about it. Check into the fund company’s reputation and find out whether or not the manager is invested in his or her own fund. You’ll start to get a feel for which funds are duds and which are true Champs.
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