What are Selection Criteria for Mutual Funds?
Introduction to Mutual Funds
As with any investment, a fund's past performance is no guarantee of its future success. Over the long-term, the success (or failure) of your investment in a fund also will depend on factors such as:
* the fund's sales charges, fees, and expenses;
* the taxes you may have to pay when you receive a distribution;
* the age and size of the fund;
* the fund's risks and volatility; and
* recent changes in the fund's operations.
So, look at more than the fund's past performance when making your investment decisions. Read the fund's prospectus and shareholder reports, and consider these tips:
Scrutinize the fund's fees and expenses - Funds charge investors fees and expenses. A fund with high costs must perform better than a low-cost fund to generate the same returns for you. Even small differences in fees can translate into large differences in returns over time.
Know how the fund impacts your tax bill - The law generally requires a fund to make a capital gains distribution to shareholders if it sells a security for a profit that can't be offset by a loss. If you receive a capital gains distribution from a fund, you will likely owe taxes on it - even if the fund has had a negative return since you invested in it.
Consider the age and size of the fund - Before investing in a fund, read the prospectus to find out how long the fund has been operating and the asset size of the fund. Newly created or small funds sometimes have excellent short-term performance records. Because these funds may invest in only a small number of stocks, a few successful stocks can have a large impact on their performance. But as these funds grow larger and increase the number of stocks they own, each stock has less impact on the fund's performance.
Consider the fund's portfolio turnover rate - A fund's portfolio turnover rate measures the frequency with which it buys and sells securities. A fund that rapidly buys and sells securities may generate higher trading costs and capital gains taxes.
Think about the volatility of the fund - While past performance does not necessarily predict future returns, it can tell you how volatile a fund has been. Generally, the more volatile a fund, the higher the investment risk. Read the fund's prospectus and annual report, and compare its year-to-year performance figures. One might have had a few years of spectacular performance and a few years of low (or negative) returns, while the performance of the other may have been much steadier from year to year.
Factor in the risks the fund takes to achieve its returns - Read the fund's prospectus and shareholder reports to learn about its investment strategy and associated risks. Funds with higher rates of return may take risks that are beyond your comfort level and are inconsistent with your financial goals. But remember that all funds carry some level of risk.
Ask about recent changes in the fund's operations - Has the fund's investment adviser or investment strategy changed recently? Has the fund merged with another fund? Operational changes such as these can affect future fund performance.
Check the types of services offered and fees charged by the fund - Read the fund's prospectus to learn what services it provides to shareholders. Some funds provide special services, such as toll-free telephone numbers, check-writing privileges, and automatic investment programs. You should find out how easily you can buy and sell shares and whether the fund charges a fee for buying and selling shares. You can expect funds that require extra work by their managers, such as international funds, to have higher costs.
Assess how the fund will impact the diversification of your portfolio - Generally, the success of your investments over time will depend largely on how much money you have invested in each of the major asset classes - stocks, bonds, and cash - rather than on the particular securities you hold. When choosing a mutual fund, you should consider how your interest in that fund affects the overall diversification of your investment portfolio. Maintaining a diversified and balanced portfolio is key to maintaining an acceptable level of risk.
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