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Selecting from the Mutual Fund Grocery Store Shelf

My daughter and son-in-law teach in the American International Schools, and the good news about THAT is that papasan (that's me) gets to visit them wherever they are in the world. During my last visit to see them in Venezuela, I went to the grocery store a number of times and found a very limited selection for nearly all items. There might be four choices of dry cereal and maybe two choices of coffee-none decaf-or two types of bread. The options were limited, which was fine for me since it made the selection process pretty easy.

In American grocery stores the shelves are stocked with many different brands, container sizes, preparations, mixes, types for each product a person might want. There are so many options that one might become paralyzed by bewilderment-and exactly that has happened to me a time or two when I was looking for something I don't usually buy. How do you figure out which option is best?

Mutual Fund Selection Options:

When you first set out to pick a mutual fund to invest in, it's more like an American grocery store than one in Venezuela because you have a bewildering array from which to choose. There's something like 10,000 plus mutual funds in existence; which, as it happens, is a higher number than the roughly 7,000 companies listed on the stock exchanges for the fund managers to buy. Amazing! To complicate matters, there's nearly an endless variety of fund types. There are stock funds, bond funds, money market funds, balanced funds, asset allocation funds, specialized sector funds for just about every industry, so called "green" funds that don't invest in anything that pollutes, social consciousness funds that will have nothing to do with any company that deals with war material in any way; and on, and on.

So, how does a person set about making mutual fund selection that meet his/her needs from this sometimes confusing number of choices?

Selection Guides:

I'll tell you about some guides that might help; and, you should probably also keep looking for other guides to help you choose because this list won't be exhaustive.

• Developing goals for your investment program will help you make choices. Funds are oriented toward differing objectives such as growth of capital, preservation of capital, providing interest income. Think though your needs including what amount of income you will need for retirement.
• Consider your risk level. It would probably be inappropriate for a person who is entering retirement to invest in wildly volatile sector funds. There's another article here on the ITS: FYI page you might want to read titled "Risk Tolerance, Self Assessment Exercise."
• Fund costs are a factor to consider. Funds will have basically the same fee level (percentage of your invented total) for managing the funds. The major difference in costs has to do with "loads" the fund management company may impose on the investor. Funds can be "front loaded" (they take their money when you invest with them), or "back loaded" (they take their money when you take out your money); or, funds can be "no load" wherein you pay management fees (like with every fund) but there is no front or back fee involved. Whenever possible, pick a no load fund.
• Fund performance is obviously an important thing to know, and you'll want to compare the performance of funds you have under consideration. In doing so, don't only look at and compare the last twelve month figures because sometimes funds that spectacularly beat the market in one year will crash just as spectacularly the next. You also want to compare funds for three, five, and ten year performance. Sometimes you won't get ten year performance figures because the funds isn't that old; but do check them out for as long as you can.
• A good standard against which to measure fund performance is the Standard & Poor 500 Index (the S&P 500). This index can be found in nearly every newspaper and is considered to be a good measure of the overall stock market. So, you'll want to compare funds you are considering with the S&P 500 index or some other similar measure of the market. Sometimes the fund prospectus (you should definitely read it) will show comparison to the market-sometimes not. If not, you can do that yourself.

Developing a Comparison Table:

Here is a table I constructed for this article of one, three, five, and ten year S&P 500 Index prices.

Historic S&P 500 Price Study Dated July 5, 2007

Now, in this instance, all percentages figures represent gains from history to now. That won't always be the case because the market goes up, but it also goes down and right now it is near an all time high. What that means is that you'll need to do the table anew each time you want to make such a comparison.

You can get the information for the table by going to http://finance.yahoo.com. On the website home page, click on "S&P 500" in the menu under "Symbols." Click on "Historic Prices"; enter the historic dates you want with the beginning date and ending date straddling the date you want. Make note of the closing price for your table. Repeat this process for the other time frames you will use in the table.

Once this table is completed, you can compare the S&P 500 performance with that of the funds you are evaluating.

One bit of information to think about is this. Of all the stock mutual funds out there, 75% DO NOT beat the market as measured by the S&P 500 Index. Some do. For example, when Peter Lynch was manager of the Fidelity Magellan fund he out performed the market nearly every year; but then, not every fund manager is a Peter Lynch.

So, you have a one in four chance of picking a stock mutual fund that performs better than the S&P 500 Index. Those aren't very good odds, but some actually do better than that.

Summary:

In order to make sense of the confusing array of mutual fund choices, one should develop some criteria for making the selection with which to compare one fund with another. Your goals, your risk tolerance level, fund costs, and fund performance represent some criteria available to you.

arley