By Barbara O’Neill, Ph.D., CFP®, AFC® and
Martie Gillen, Ph.D., MBA, AFC®, CFLE
Personal Financial Managers often get questions about mutual funds and the Thrift Savings Plan’s Mutual Fund Window (MFW). The first mutual fund opened in 1924 and is still in existence today. Since then, generations of investors have faced the task of selecting mutual funds that are appropriate for their investment needs. In 2021, there were almost 7,500 mutual funds to choose from.
What to do? Consider five key mutual fund selection criteria and five “deal-breaker” fund features to avoid.
- Fund Objective– A mutual fund’s objective should match an investor’s. For example, a 20-something service member investing for retirement in the MSW or a taxable account should consider funds with a growth objective (e.g., stock index funds or age-appropriate target date funds).
- Fees and Expenses– Investors should seek mutual funds with below-average expenses for their category (e.g., growth funds). To do this, compare the expense ratios (i.e., fund expenses as a percentage of net average assets) of at least three similar mutual funds. The lower the percentage, the better (e.g., 0.20% vs. 1.2%).
- Historical Performance– This data is available from mutual fund prospectuses and independent research/rating firms. Look for sustained above-average performance (e.g., 1, 3, 5, and 10 years) compared to peer funds and/or relevant market indices (e.g., the Standard and Poor’s 500 index for U.S. large company stocks).
- Investment Policies– A fund’s investment policies should align with an investor’s personal investment risk tolerance. For example, conservative investors would not select funds that invest in low-rated “junk bonds” or aggressive growth funds that use options, short-selling, and other high-risk strategies.
- Minimum Deposits– Mutual funds must have affordable minimum initial and subsequent deposit amounts for investors to invest in them. Again, this data is available from fund prospectuses and research/rating firms. Some mutual funds open accounts with $500 or less while others require $3,000 or more.
Deal-breakers are features of a product or service that cause people to walk away from a purchase. In other words, they are deemed to not be acceptable. Below are five deal-breakers to consider for mutual funds:
- Load Funds– Whether loads (sales charges) are front-end or back-end, they are an extra expense that can be avoided with no-load mutual funds.
- 12b-1 Fees– This fee charged to market mutual funds is also an extra expense that can be avoided with no-load mutual funds.
- Sector Funds– These funds that invest only in one industry sector (e.g., technology) are limited in the amount of diversification that they provide.
- Poorly Performing Funds– It is unwise to invest in funds that have not shown any previous ability to provide above-average returns.
- Newcomers– It is risky to invest in mutual funds without an experienced manager or a multi-year performance record to assess.
Expand your mutual fund knowledge in this webinar.
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