The Retirement Corporation of America

How To Pick The Right Mutual Funds

PICKING THE RIGHT mix of mutual funds for your specific needs isn't quite like finding a needle in a haystack. But picking a handful of funds from more than 8,000 poses some problems. You can make the job a lot easier by making your way through these simple-to-follow mutual fund shopping tips:

•  How much research do you want to do? If you don't want to wade through heaps of conflicting opinions on which stock funds to buy, for example, pick an index fund.

•  Look at funds that have stood the test of time. A cardinal rule of investing is: Don't buy on past performance. But you have to start somewhere. Get the latest quarterly mutual-fund roundup out of a newspaper or magazine, and see which of today's best-performing funds have also done well over longer periods of time—over three years, five years, and even 10 years.

•  Compare apples to apples. You want to know how well one aggressive-growth fund stacks up with another, or how well one short-term bond fund has done compared with other short-term bond funds. It's also helpful to compare performance records in both up (bull) and down (bear) markets.

•  Understand the yardsticks. The one you'll see used most often by newspapers and magazines in their quarterly mutual fund roundups is "average annual total return." This is how much the fund has returned over time—on average. There would have been bad years and very good years along the way. You're keeping time on your side, so you want to know how much the fund returns on average over time—three years, five years, or even longer.

•  Compare stock funds against the right benchmarks. See how well a fund you're considering measured against major stock indexes, such as the Standard & Poor's 500 stock index and the Dow Jones average of 30 industrial stocks. Use this comparison for guidance—how well the fund did against the index that best represents whatever the fund invests in.

•  Buy funds with the lowest expenses. The more you pay in annual expenses, the less money you have working for you. The longer your time horizon, the more important this becomes. If you have 30 or 40 years to go until retirement, a 1 percent difference in annual fees adds up to big money. Don't pay more than 1.2 percent per year for stock funds and less for bond funds.

•  Buy from a no-load fund family. Nearly 75 percent of no-load funds, accounting for 90 percent of the assets in these funds, are sold by companies offering several kinds of funds. You can usually switch funds with a toll-free phone call.

•  Ask the fund company for help in making your investment selections. Do listen to what the fund's telephone representatives have to say. Don't base all your investment decisions on what other people tell you, but if you tell the telephone representative what your situation is and what your goals are, you'll usually get useful advice on which of the company's funds to select. Keep asking questions until you get answers you feel comfortable with.

•  Be realistic. You don't have to pick the best single stock fund and the best single bond fund to make your mutual fund investment strategy a success. In the end, there will be dozens—maybe even hundreds—of funds that will do well enough for you over time. Shop among the big fund families, pick funds with performance records that have been consistently good over time, and pick funds with low fees and expenses. You will wind up with funds that will deliver what you want your mutual fund strategy to deliver.

•  Don't assume bigger is always better. It's tempting to chase after the biggest mutual funds. They tend to get the most attention in the press. Yet Sheldon Jacobs, editor of The No-Load Fund Investor, a mutual fund newsletter, found that in one recent year "36 of the top 50 best-performing equity funds had $50 million or less in assets." Jacobs tracked those figures for many years and found that results are always the same. The bigger funds become, the more they act like dinosaurs. They are hard-pressed to find profitable ways to invest the torrents of new money that pour in each day. Some funds deal with the problem by closing their doors to new investors.

The problem of "too big to be good" seems to apply only to stock funds. Jacobs says that when it comes to bond and money market funds, size is a plus, because the bigger the fund, the lower each investor's share of the expenses is.