for Mutual Funds
The last time I looked, the overall market, as measured by the S&P 500
index was still up slightly for the year.
But that news would be of little consolation to holders of MGM Mirage,
Continental Airlines or Callaway Golf. As of last Wednesday, these,
along with more than 160 other stocks, had dropped at least 50%
so far this year.
By contrast, 7,893 of the 10,161 domestic stock mutual funds tracked by
had racked up returns ahead of the S&P 500 so far this year.
Those figures illustrate the advantage of owning mutual funds. Most
funds hold dozens, if not hundreds of stocks, so you get automatic
diversification. One or two disasters don’t move the needle on the
entire portfolio by much.
Here’s a screen for pinpointing worthwhile mutual fund candidates. If
you’re not familiar with the term, screens are programs you can use to
search out funds meeting your selection criteria. I’ll use Morningstar’s
free and user-friendly fund screener to demonstrate the process. From
Morningstar’s homepage, select Funds and then click on
Fund Screener (Tools menu).
Say No to Loads
Start by selecting “No-load funds only” from the “Load Funds” dropdown
menu. Loads are sales commissions used to compensate financial advisors
who select mutual funds for their clients. The professionals deserve to
be paid for their work, but there’s no point in paying the fee if you
are selecting funds on your own.
Required First Purchase
Next, use the “Minimum Initial Purchase” menu to specify $3,000. That
means your first purchase of each fund must be at least $3,000. Usually
after your first purchase, you can add to holdings in a fund in much
smaller increments. Other choices range from $500 to $10,000. Pick the
amount that suits your needs.
The ideal mutual fund would deliver market-beating returns with minimal
price swings, which is termed “volatility.” Most analysts equate
volatility to risk.
Morningstar’s Star rating compares a fund’s historical returns to its
historical volatility. The ratings run from one to five stars, where
five is best. The funds with the highest return vs. volatility ratio in
each category (e.g. value, technology, energy) earn five stars. While a
five-star rating doesn’t guarantee future performance, it’s a good
Next, use the Morningstar Risk dropdown menu to specify low risk. In the
stock market, when it comes to risk, lower is always better.
This selection strategy is about spotting funds with market beating
historical returns in the hopes that they will continue their winning
ways. Use the one-year, three-year and five-year return menus and
specify that average annual returns must equal or exceed the S&P 500
Index returns over those periods.
Historical performance is meaningless if the fund manager responsible
for the results is no longer running the fund. Use the Manager Tenure
dropdown menu to specify a five-year minimum tenure.
Click the “Show Results” button to see the list of qualifying funds.
When I ran it, Morningstar listed 52 funds. Use the View menu at the top
to switch to the Performance view, which shows each fund’s returns over
a variety of timeframes.
MStar Lists Wrong Funds
One caveat, Morningstar listed some funds, labeled “Load Waved,” that
are really load funds and are available only through financial advisors.
The more you know about a fund, the better your results. So consider the
funds turned up by this screen as candidates for further research, not a