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How
to Pick the Best Mutual Funds
In my last column, I described
how to search for promising mutual fund candidates using Morningstar’s
free mutual fund screening program. Here’s how to research the funds
turned up by that screen, or found by any other method, to pinpoint the
best candidates.
Basic Requirements
In the screening column, I
suggested looking for no-load funds rated five stars by Morningstar,
rated “low” risk by Morningstar, and with three- and five-year
historical returns greater than the S&P 500 index. I also required that
the same manager had been running the fund for at least five years.
Finally, I suggested that passing funds should have minimum initial
purchase requirements consistent with your needs. Check the screening
column for the rationale behind those requirements.
I’ll use Morningstar to demonstrate the analysis process. Start by
entering your fund’s name or ticker symbol on Morningstar’s homepage (www.morningstar.com)
to see the
Snapshot report for the fund. Eliminate a fund as soon as it flunks
any one test.
MStar Rating, etc.
Check Morningstar’s Star Rating listed at the top of
the report, after the fund name. Rule
out funds rated less than five stars.
Next, confirm that the fund is no load by looking for the word “none”
under "load" near the top of the report.
Disqualify load funds.
Morningstar also lists the required minimum
initial investment in the same section. Rule
out funds that require starting investments above your limit.
Ratings & Risk
Access the
Ratings & Risk report and check
Morningstar “overall risk” rating. Risk-averse investors should avoid
funds with ratings other than “low.” It's okay to
also accept “below average” ratings if you have a higher risk
tolerance.
Morningstar’s risk rating compares a fund’s volatility to other funds in
its same category (e.g. small-value, banks, tech stocks, etc.). It’s
also important to check Standard Deviation (Volatility
Measurements), which measures volatility on an absolute basis.
That’s important because excess volatility is
what keeps you awake nights and incites you to sell just when a fund has
touched bottom.
Standard deviations run from as low as 1 to has high as 30, and
sometimes higher. The higher the number, the more volatile the fund.
Risk-averse investors should avoid funds with standard deviations above
10, and all investors should rule out funds with values above 15.
Manager Tenure
Check the “manger start date” in the
Management report and rule out funds if the manager has been on the
job less than five years.
Returns
Switch to the
Performance report to see calendar year and trailing returns.
Calendar year returns are for specific years such as 2007 or 2008.
Trailing returns are the average annual returns for periods ranging from
one day to 10 years, if the fund has been around that long. Because they
are computed daily, the trailing returns are more relevant than calendar
year returns.
Morningstar also compares each fund’s performance to the S&P 500 index
for each period. That figure will be positive if the fund outperformed
the index and negative if it underperformed.
Start with the trailing 3- and 5-year returns vs. the S&P 500. Passing
funds must have outperformed the S&P by at least 5 percent over both
periods. Also check the one-year return vs. the S&P index. Since that is
a relatively short timeframe, require only that the fund match the S&P’s
return. Ignore year-to-date and shorter timeframes.
I’ve described the most important factors to consider when evaluating
funds, but I don’t have room to list everything. For more fund analysis
information, check Morningstar’s Investing Classroom (under Learn on
Mutual Fund main page).
published 7/19/09 |
