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Get your mutual fund a checkup

Richard Loth

“They pick a fund largely on the basis of recent performance and with insufficient data about how the fund and its manager operate.” That’s how syndicated columnist Chuck Jaffe recently described most mutual fund investors. That opinion might seem a little harsh, but, unfortunately, I’d have to agree.However, employing a few relatively easy-to-understand tests on their mutual funds could change this circumstance for fund investors and make a positive difference in their investing results. Using a simple seven-step fund checkup will at least cover the basics they need to know – and it’s much better than guesswork.What data should you work with? Forget about using mutual fund prospectuses, annual reports, and statements of additional information – they’re simply too hard to read. Also, I’ve found that fund profiles provided to retirement-plan participants by plan providers are too simplistic, often leaving out some key evaluative information points.Comprehensive fund reports are available from Morningstar, Standard & Poor’s and Value Line. I use all three but prefer, as a single source, Morningstar’s reports, which readers can access free of charge at the Avon and Vail libraries, or through a Morningstar Premier Member subscription ($125). Using Morningstar for a seven-step checkupFirst, find the box in the report with the caption “Historical Performance.” Don’t be seduced by the “stars.” While more is better, the star ratings are purely quantitative, only relate to a fund’s particular category – as opposed to the whole fund universe – and are strictly backward-looking. Instead, focus on just two words, “risk” and “return,” which speak volumes about a fund’s investment qualities. At the very least a fund’s risk and return should be commensurate. However, what you really want to see is an average or low-risk rating with above-average or high return. Those are winning combinations.Second, track the fund’s historical investment objective from the boxes in the “investment style” section. Look for compatibility with your investing position and consistency. If changes seem to be more than transitory, call the fund and ask why. Third, check the “portfolio manager(s)” section to make sure that the fund’s performance is attributable to the current management. New management and/or frequent manager changes send a caution signal and should be questioned. For funds that are indexed or run by a management team, this checkpoint is not that relevant.Fourth, in the “history” section you’ll find the all important “expense ratio.” Because low-cost funds outperform high-cost funds, you’ll want to see domestic stock funds and bond funds with expense ratios below 1 percent and 0.5 percent, respectively. Funds with loads (sales charges) and 12b-1 fees (see data at the bottom of the report) should be avoided.Fifth, excessive portfolio turnover causes high brokerage transaction commissions and increases the potential for capital gains tax consequences. I like to see stock funds with a “turnover rate” (in the “history” section) below 30 percent. Because of the nature of their securities, bond funds have high turnover.Sixth, a fund’s total return is found in two places: The “history” section provides yearly figures over a 12-year span. In the “performance” section, under the “trailing” caption, you’ll find one-, three-, five-, 10- and 15-year annual average figures for the fund, the S&P 500 Index, and a relevant fund category index. The fund’s numbers should be better than the index numbers.Lastly, look for the fund to be classified as a “Morningstar analyst pick” (noted at the top of the report), which implies a very high quality, consistent performer. Next, read carefully Morningstar’s evaluative commentary in the “Morningstar’s Take” section. Obviously, here you’ll want to see a positive slant and/or the absence of any cautionary remarks.If you perform this seven-step checkup before you purchase a fund, and at least once a year after you own it, you’ll know what you own and why you own it – two basic principles of smart investing.The Investing Wisely column is written by Richard Loth, managing principal of Mentor Investing and an independent registered investment adviser. Loth can be reached at 827-5591 or mentorinvesting@comcast.net.Vail, Colorado


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