Investor’s Capital Management

Fee-Only Investments & Financial Planning

Five Important Characteristics of Mutual Funds

When choosing a mutual fund, there is an enormous amount of data available, however there are only a few really important items to consider. Here are my favorite five characteristics to use for comparison:

1. Style purity

We want a fund that sticks to a certain investment style. Using a Morningstar page, look at the style boxes across the top (labeled "Investment Style"). We want to see a consistent style being used. This fund is Large-Growth and is consistently in that one style. This fund shows excellent consistency.

2. Low Expenses

The lower the expenses the better since the fund's expenses are deducted directly from your return. Look under "History" (right side) for the Expense Ratio row. It shows 0.64% for the recent period. Since the average growth fund charges about 1.3%, the expense ratio is much better than average for our sample fund.

3. Low cash positions

Cash is normally a drag on performance. Most mutual funds keep some cash around because investors can ask for their money back anytime. Look at "Composition" (lower right). Our sample fund has 2.6% in cash - better than average.

4. Potential Capital Gains

When you buy into a mutual fund, you are buying into a possible capital gain even though you may not have been an owner of the fund when the gains were made. To check for the likelihood of this, look for "Tax Analysis" along the left side and below that, see "Potential Capital Gain Exposure". For the sample fund the exposure is negative. Outstanding - because there are actual losses the fund manager can use against future gains - protecting you from capital gain distributions.

5. Consistent Relative Performance

Look for "Performance Quartile" near the top (below the style boxes). We want to purchase funds that consistently beat their peer funds. The sample fund has been in the top 25% 5 years out of 11 (not counting the partial 2001 year) and in the top 50% 10 years out of 11. That's excellent relative performance. Quarterly relative performance can be viewed on the line labeled "Fund Performance vs. Category Average"