Mutual Funds
5 Ways to Vet a Fund
Here's how to identify the most important information
By Russel Kinnel, Contributing Editor, Kiplinger's Personal Finance
August 2009
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It's easy to overdose on data when choosing funds. Numbers can be interesting, but only a few really help you make good selections. Unfortunately, many investors have a hard time figuring out which stats to use and, all too often, make the mistake of leaning too heavily on a fund's returns over the past year. My new book, Fund Spy (Wiley, $24.95), is designed to help you identify the most important information. Here are some things you should look at:
Expense ratio. This one's simple: You improve your odds of success by investing in funds with low fees. Over a ten-year span, stock funds whose annual expense ratios are among the lowest 20% in their categories are 40% more likely to outpace those in the second-cheapest quintile. And the least-expensive funds are more than twice as likely to outperform those with expenses in the highest 20% of their categories.
Stewardship. Some funds watch out for shareholder interests, and others treat investors as if they were second-class citizens. For instance, some sponsors will keep a fund open to new clients even though existing shareholders would be better served if the fund closed. Over a lengthy holding period, a fund company will have many opportunities to choose between maximizing profits and protecting shareholders. I want the good guys on my side. Steer clear of funds with Morningstar stewardship grades of D or F.
Risk. Most investors are better off avoiding high-risk funds. That's because it's tough to stay put when a highly volatile fund gets whacked, even though holding steady might be the right course of action. Morningstar's risk rating gives you a quick assessment of how dangerous a fund could be.
The bear market that ended (I hope) on March 9 also provides a very real measure of funds' risks. Check how a fund fared in 2008, during which the stock market tumbled 37%. In fact, before you buy a fund, look back over at least ten years' worth of returns to see how it fared in different climates. This should enable you to set realistic expectations and prepare you better for potential losses. But you should also ponder how you handled losses during the bear market. If you couldn't stand the pain in certain funds and unloaded them, then look for more-conservative investments.
Manager stake. In 2005, regulators started requiring managers to disclose how much of their own money they had invested in their funds. But that information is buried in the mountains of paperwork that funds must file, and few investors have the time, patience and inclination to ferret it out. Fortunately, we've loaded the data into our computers at Morningstar.
It makes sense to follow the lead of insiders. After all, who knows a fund better? It turns out that fund managers are all over the place when it comes to putting their money where yours is. Most don't have a dime in their funds, yet hundreds have more than $1 million invested. Consider a fund only if at least one of its managers has $500,000 or more invested in it. (The rule does not apply to money-market funds, but it does to just about every other category.)
To see how your fund rates on the criteria described above, take the Spy Selector test.
Management quality. The final step -- identifying good managers who employ sound strategies -- is the subjective part of the process. You can learn a lot from fund shareholder reports, and from reports at Morningstar.com, Kiplinger's and other sources. In Fund Spy, I identify the great fund com-panies and the also-rans. I also describe 20 great funds that pass my tests. Among them are Harbor Bond, T. Rowe Price Small-Cap Value and Dodge & Cox International Stock, all members of the Kiplinger 25.
Columnist Russel Kinnel is director of mutual fund research for Morningstar and editor of its monthly FundInvestor newsletter.
Reader Comments (3)
Posted by: DG at 07/28/2009 04:11:18 PM
I like to check total assets also - though this probably is related to stewardship and may correlate to some of the others. Once a fund gets too big for its investment universe, it may be better to choose another and in some cases even move an existing account.
Posted by: Limoman at 07/29/2009 11:13:21 PM
Expenese? Well I have to disagree.. It's like being a Penny Wise and A Dollar short.. I mean? If the higher Fee Fund is making 2-5% or more than the lower fee Fund and you end up 1.5%-3.5% ahead of the game? I don't see why not..using the rules of 72 tells me it's worth it..even in 10-12 yrs, let alone 20-30 yrs...and I agree on Watch the Total Assets..Only American Funds has shown me they have been able to handle Big Assets, the others? Not so much..D&C has lost it's way and not doing anybetter than Indexes and DODFX? The Bottom fell out of it..I think the only reason DODFX looked good, it wasn't In business during the Whole 00-02' Yr and if you looked at the Comparable Index, it would have done just about as poorly..manages Stake? Sorry, I think that can be very misleading too..There are Ways to show you have 10-20% of your Alledged $ in your Fund and you really don't or So what if you have 10-20% in it? If you have the other 80-90% in Bonds? and your making Several Million a yr to make up for loosing 50% of that 10-20%... and they all justify why they don't have More in their Funds by saying Diversification is the reason.. Bill Gross and Warren Buffet & some others are an exception.. High Risk funds? I fully agree! And probably som 90% or more don't really need more than to own Both VWELX and VWINX to get a 50/50 Port and start adding extra Bonds once one hit's age 50... and have 30/70 by the time they Retire...and not focus on what you 'could of Made' but what you could have Lost by looking at just Bear yrs of a Fund adn odds are now 40% chance the yr or so before you want to retire? It will be a Bear Yr and your sunk..and Beating the Indexes by 1-2% maybe important to those with 20 yr horizons, but not for those with 10 or less.. and even more so using Alot more Bonds , since they have made ave of 1-2% less now for over 40 yrs.. Big deal just like a 50/50 Port vs a 70/30...
Posted by: Jaywalker at 08/01/2009 10:29:34 PM
Limoman, I believe you're missing Mr. Kinnel's point. Sure, if a fund makes better returns you'll be better off in them, but the point is you don't know in advance which acive funds will be better. His statistics show that cheaper funds tend, over time, to give better returns than more expensive ones. So, in the absense of future knowledge, you're beter off with cheaper ones. Also, taken to the extreme, this means we're better off with index funds, which is consistent with most studies.