Picking The Right Mutual Fund

Identifying Goals and Risk Tolerance: Are long-term capital gains desired, or is a current income preferred? Will the money be used to pay for college expenses, or to supplement a retirement that is decades away? Identifying a goal is important because it will enable you to dramatically whittle down the list of the more than 8,000 mutual funds in the public domain. In addition, investors must also consider the issue of risk tolerance. Identifying risk tolerance is as important as identifying a goal.

Style and Fund Type: If the investor intends to use the money in the fund for a longer term need and is willing to assume a fair amount of risk and volatility, then the style/objective he or she may be suited for is a long term capital appreciation fund. Conversely, if the investor is in need of current income, he or she should acquire shares in an income fund. Of course, there are times when an investor has a longer term need, but is unwilling or unable to assume substantial risk. In this case, a balanced fund which invests in both stocks and bonds, may be the best alternative.

Charges and Fees: Some funds charge a sales fee known as a load fee, which will either be charged upon initial investment or upon sale of the investment. A front end load/fee is paid out of the initial investment made by the investor while a back end /fee is charged when an investor sells his or her investment, usually prior to a set time period, such as seven years from purchase. The investor should look for the management expense ratio. The ratio is simply the total percentage of fund assets that are being charged to cover fund expenses. The higher the ratio, the lower the investor's return will be at the end of the year.

Evaluating Managers/Past Results: As with all investments, investors should research a fund's past results. To that end, the following is a list of questions that perspective investors should ask themselves when reviewing the historical record:

• Did the fund manager deliver results that were consistent with general market returns?
• Was the fund more volatile than the big indexes (meaning did its returns vary dramatically throughout the year)?
• Was there an unusually high turnover (which can result in larger tax liabilities for the investor)?

This information is important because it will give the investor insight into how the portfolio manager performs under certain conditions, as well as what historically has been the trend in terms of turnover and return. For this reason, prior to buying into a fund, it makes sense to review the investment company's literature to look for information about anticipated trends in the market in the years ahead.

Size of the Fund : However, there are times when a fund can get too big. A perfect example is Fidelity's Magellan Fund. Back in 1999 the fund topped $100 billion in assets, and for the first time, it was forced to change its investment process to accommodate the large daily (money) inflows. Instead of being nimble and buying small and mid cap stocks, it shifted its focus primarily toward larger capitalization growth stocks. As a result, its performance has suffered. It makes the process of buying and selling stocks with any kind of anonymity almost impossible.

Bottom Line: Selecting a mutual fund may seem like a daunting task, but knowing one's objectives and risk tolerance is half the battle. If one follows this bit of due diligence before selecting a fund, one will increase one's chances of success.

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Veena Vishwanathan

Globsyn Business School