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Four Questions To Ask Yourself |
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Written by Value Seeker
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Tuesday, 18 September 2007 |
Don't invest in a mutual fund unless you are comfortable with the answers to these four questions.
There are a variety of factors to look for when evaluating a mutual fund. Here is a brief summary of four key variables that should affect your decision of whether or not to invest in a fund.
1. What fees does the mutual fund charge? The more money you pay in fees, the less you make in returns. Mutual funds charge two groups of fees: management fees and marketing fees. The management fees are to be expected since the mutual fund is doing a service for you by investing your money. However, you want to keep this fee to under 1.5%, preferably under 1%. The second type of fees, marketing fees, are unnecessary to pay. Why should you pay extra money so the mutual fund can advertise the fund? Mutual fund marketing fees appear as "loads" or "12b-1" fees. Whatever the case is, avoid funds that charge these fees.
2. How much confidence do you have in the fund's manager? The main reason to invest in a mutual fund instead of buying an ETF (or just buy a bunch of random stocks) is because you believe the fund's manager has expert stock picking skills. If you do not think the manager has what it takes to beat the market, then just invest in an ETF or pick stocks yourself. The fees mutual funds charge alone will make them lose to almost all ETFs unless the fund's manager has better-than-average stock picking abilities.
3. What sectors and stock types does the fund target? While some mutual funds are broad funds, most focus on a sector (such as tech) or a stock type (such as small caps or foreign stocks). If you are looking to diversify your portfolio, consider whether a certain fund will help achieve that diversification. Also, when evaluating a fund's performance, compare it to its peers, not just a broad index like the S&P 500. Comparing a foreign small cap fund to the S&P 500 is comparing apples to oranges.
4. How large is the fund? In general, the smaller the mutual fund is the better. When a fund gets large, it makes it more difficult to make investment decisions. For example, a $50 billion mutual fund cannot take a reasonable position in a company worth $500 million. Even a $10 million position (which is 5% of the company) represents just .02% of its portfolio. Furthermore, when a large fund like this begins buying a stock, it pushes the stock's price up. Therefore, it becomes more and more expensive for the mutual fund to develop a meaningful position in a company.
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