The great thing about our annual mutual fund guide is the large number of funds it covers and the significant amount of information it provides about each fund. As useful as this data is, it can admittedly be overwhelming to a person without a plan for identifying a new fund (or funds) to invest in. Fortunately, this does not have to be the case. I’m going to walk you through the basic steps you need to follow when selecting a new mutual fund. This advice is, in large part, also applicable to exchange-traded funds (ETFs) and closed-end funds (CEFs).
I realize the first thing many of you want to me to discuss is performance, but I would encourage you to take a step back momentarily and consider a more important trait: a fund’s category. Your very first question when selecting a fund should always be “what type of fund am I looking for?” Are you in need of a bond fund? Do you want a fund manager to handle asset allocation decisions for you? (A target-date or balanced fund works well for this.) Are you seeking exposure to international markets? Answer this question first and you will save yourself considerable time. You will also make a better decision about which fund to buy.
Since performance is on most of your minds, let’s talk about it. Recent performance (e.g., one-year) attracts headlines, but five- and 10-year performance figures give much better insight into how a fund has truly performed. Having written about many funds, I can tell you that there is no substitute for looking at the year-by-year return data as well as how the fund performed during the last bull and bear markets (if the fund is old enough to have calculated returns for both). These numbers reveal how volatile a fund has been and can suggest the types of markets the fund fares well or poorly in.
I’ll give you an example. Matthew 25 (MXXVX) has the best five-year annualized performance among non-leveraged large-cap funds. If you were to solely select a fund based on its five-year annualized return of 22.9%, you would think that Matthew 25 is a long-term winner. A look at the year-by-year returns might change your opinion, however. The fund has underperformed the large-cap category average during five out of the last 10 years, including last year.
This brings up another big point: Compare a fund against its peers. Fund managers are beholden to their objectives. If a fund’s category has a lackluster year, as emerging market stocks did in 2014, there isn’t a much a manager can do. While you could focus your efforts on the categories with the best recent returns, by doing so you will always be chasing short-term performance.
You should also look at how long a fund’s manager has been at the helm. Whenever a fund manager leaves, particularly one who follows a hands-on active approach, the fund’s performance walks out the door with him or her. (Bill Gross’ departure from PIMCO is a good example.) The departure of a manager is far less of a problem for funds following a quantitative approach and it shouldn’t be an issue for index funds.
These steps alone should narrow the down the number of candidates to a workable list. From here, you can get into details such as the fund’s expense ratio, its strategy and account minimums. Lower costs are always preferable. Looking at the fund’s prospectus, reading the manager’s commentary (if it is provided) and looking at the top holdings will provide insight into how a fund is run. For example, Wasatch-Hoisington US Treasury (WHOSX) has realized its good five-year performance by making large bets that interest rates will stay low. Account minimums and any minimum requirements on subsequent investments will indicate the smallest amount you can invest in a fund.
Finally, once you buy a fund, take a long-term view. Constantly buying and selling based on short-term performance often leads to worse returns. While you shouldn’t hold onto a long-term laggard, you also shouldn’t be quick to sell just because of one bad year, especially if the fund’s category peers also struggled.
- Qualitative Guidelines for Mutual Fund Selection – Beyond the numbers, there are factors that can help you determine whether or not a particular fund is a good investment.
- The Truth About Top-Performing Mutual Fund Managers – Even the best fund managers will underperform at some point, though investors are often rewarded for staying with them.
- How Do You Use AAII’s Annual Mutual Fund Guide? – Tell us on the AAII.com Discussion Boards.
The U.S. financial markets, and our offices, will be closed on Monday in observance of Presidents Day.
I will speak to our Chicago chapter on Saturday, February 21. Next month, I will speak in Phoenix and Albuquerque and my colleague, Wayne Thorp, will speak in Delray Beach and Ft. Lauderdale, FL. For those of you not in those areas, visit our local chapter page for information about meetings near you.
Currently, 50 members of the S&P 500 are scheduled to report earnings next week. The only Dow Jones industrial average component in the group is Wal-Mart Stores (WMT), on Thursday.
The week’s first economic data will be the February Empire State manufacturing survey and the National Association of Home Builders’ February Housing Market index. Both will be released on Tuesday. Wednesday will feature January housing starts and building permits, the January Producer Price Index (PPI), January industrial production and capacity utilization and the minutes from the January Federal Open Market Committee Meeting. Thursday will feature the February Philadelphia Federal Reserve survey.
Philadelphia Federal Reserve Bank President Charles Plosser will speak publicly on Tuesday.
The Treasury Department will auction $9 billion of 30-year inflation-adjusted securities (TIPS) on Thursday.
February stock option contracts will expire on Friday.
- The Individual Investor’s Guide to the Top Mutual Funds 2015
- AAII Stock Screens 2014 Review: Active Strategies Lag
- Two New Stocks Added to the Model Shadow Stock Portfolio
The percentage of individual investors describing their short-term outlook for stocks as "neutral" surged to its highest level since last summer. The sharp rise occurred as pessimism plunged.
Bullish sentiment, expectations that stock prices will rise over the next six months, rebounded by 4.5 percentage points to 40.0%. The historical average is 39.0%.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, surged by 7.6 percentage points to 40.0%. This is the largest amount of neutral sentiment since July 24, 2014 (40.4%). The jump puts neutral sentiment above its historical average of 30.5% for the sixth consecutive week.
Bearish sentiment, expectations that stock prices will fall over the next six months, continued its recent volatility by falling 12.1 percentage points to 20.3%. The plunge puts pessimism at a six-week low. The historical average is 30.5%.
Neutral sentiment is at an unusually high level. The typical range of readings over the life of the survey is 22.1% to 39.3%. High levels of neutral sentiment have historically been followed by better-than-average gains in the S&P 500, as I explained in the June 2014 AAII Journal. This said, bullish sentiment was at an unusually high level last month and such readings have historically been followed by smaller-than-average gains in the S&P 500.
A combination of recent price volatility and fourth-quarter earnings reports have contributed to the recent swings in both bullish and bearish sentiment registered by our survey over the past few weeks. Keeping AAII members encouraged is the overall upward momentum of stock prices, comparatively low energy prices, earnings growth and sustained economic expansion. Causing other members to be cautious or pessimistic are disappointing earnings or guidance from certain companies, geopolitical events, the impact of lower oil prices on energy stocks, a sense that prevailing valuations for stocks are too high, the pace of economic growth and worries that an even larger decline in stock prices could occur.
This week’s special question asked AAII members what sectors or industries they like right now. More than 40% of all respondents said health care (including pharmaceutical and biotech stocks). Technology and energy were a distant second and third, picked by 23% and 22% of all respondents, respectively. Financial stocks were fourth, named by 15% of all respondents.
Bullish: 40%, up 4.5 points
Neutral: 39.7%, up 7.6 points
Bearish: 20.3%, down 12.1 points
Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%
Local Chapter Meetings
February 5, 2015 Euro Weakness Has Been a Drag
January 29, 2015 Indicators for Assessing the Market’s Risks and Rewards
January 22, 2015 Oil Shows the Folly of Forecasts
January 15, 2015 The Tools I Use for Managing My Finances
