Choosing A Mutual Fund
What is the most important factor in choosing a mutual fund?
When it comes to selecting mutual funds, expense ratio is really important. That's just the cost associated with running that mutual fund, and academic research has shown us that the lower the expense ratio the higher the probability that you're going to have a top performing fund over time.
What is a fund's "performance history," and is it important?
Performance history as it relates to mutual funds is just the past performance a fund; what it's historical performance has been over time. A lot of people look at that as the sole reason to invest in a certain mutual fund or the number one category the number one determinant of whether we should invest in a mutual fund, and really it needs to be the last decision factor of why we're going to invest in a mutual fund, and there's a few reason for that; one of the problems of looking at past performance is it's not telling us what the fund is doing. Is it possible that the money manager made a really big bet on a single stock and got really lucky, and so their performance looks really good but there's really not good explanation that that performance is going to continue to happen. Another potential problem about looking at past performance might relate to it's individual year by year performance. If you're looking at a five year history, you might not be picking up let's say two really really bad years; if has two really good years and so you might be missing some of the volatility, which is really going to affect you year by year. It's also possible that past performance has nothing to do with this being a good fund but the fund happens to be in a really good category and that category, whether its large growth or large value; whatever it might be a certain sector might have just gone through a really good investment cycle, and so it might be about to go into a bad investment cycle. So past performance alone can be very misleading into the really what we expect to happen going forward with a mutual fund.
Why is the fund's manager important?
If we're buying an actively managed mutual fund, it means that we're going to find a manager whose job is to predict which stocks and bonds we should own to beat the market, which is really what we're doing with that active management. The manager becomes very, very important to the mutual fund. It's that individual that we're relying upon to make those predictions, to buy the really good stocks for us, to try to beat the market.
What should I look for in a mutual fund manager?
If you're going to go after an actively managed fund, you're really relying upon the fund manager's ability to pick stocks, not the fund itself. You want to try to find out how that fund manager has done through their career. That might be at other funds, other fund families, or maybe even other investment strategies. If this fund manager has done very well with small cap stocks, but now they're running a large cap stock fund, you want to be a little concerned that this fund manager hasn't necessarily shown their experience or their ability with a different class of funds. What you really are looking out with a fund manager is their history, how well they've done with stocks or bonds - particularly with securities of the same type that they're investing now for you.
How can I objectively judge the performance of a fund?
When it comes to trying to objectively judge the performance of a mutual fund, the best way is to take that mutual fund and measure it against peers - people that are looking at the same investment strategy - and also probably an underlying benchmarker index that represents that same investment stategy. You wouldn't want to take a mutual fund and compare it against all mutual funds. You want to really try to bring down the peers that you're going to measure that fund by. A large cap value fund should really only be measured against other large cap value funds, and to the same extent measured against large cap value benchmarks. There are a lot of different ways to slice even that pie. The closer you can get to the true underlying fundamentals of the mutual fund, its peers and the benchmarks, the better you're going to be able to get a true perspective on how well that fund has done relative to its peers and benchmarks. Once again, that can still be a dangerous trap to figure out how well it might do going forward.
What is mutual fund "portfolio balancing"?
Portfolio balancing or rebalancing is the process of bringing your portfolio back to its original asset allocation. If you have a good asset allocation strategy, you should expect, over short periods of time, some investments to be doing well and some to be doing poorly. The process of portfolio balancing is really going back to your original allocation. You're going to sell what's doing well and buy what's doing poor. You're selling high and buying low, which makes a lot of sense, and fundamentally that makes sense to us. Psychologically it can be difficult: "Well, this investment's doing so well. Why do I want to sell it and buy what's doing poorly?" The reasoning is that we're assuming that all of your investments are going to do really well over time, they just cycle through different up and down markets. What rebalancing is doing is allowing us not to have to call the timing aspect of when something is going to do well and when something is going to do poorly. It's just allowing us overall a broad, diversified portfolio to succeed over time.
When should I rebalance my portfolio?
When it comes to the timing of rebalancing, there's been a lot of research on this and it doesn't seem to be a specific answer to when you should rebalance whether that's monthly, quarterly, annually. And, so rebalancing should really, I think, be a function of other aspects as it relates to the portfolio. A taxable portfolio, you probably wouldn't want to rebalance, maybe, more than annually 'cause remember when we're rebalancing, we're selling what's gone up and so if we wait a year to sell that, it's going to be a long-term capital gain versus a short-term capital gain. So, the taxes might be driving when we rebalance other than picking a certain calendar time to rebalance.
What factors should I consider in choosing a balance of mutual funds?
When choosing a balance of mututal funds the factor that you really want to consider is how each individual mutual fund plays out as part of the overall portfolio. So it's always "Why do I have this fund?" and "How is this fund going to complement all my other funds in my portfolio?" That's very different than saying: "I want to pick these five really good funds". Usually when you're looking at a group of funds that are doing very well over a period of time, whether that's five years or something like that, what you're doing is you're probably picking funds that are very similar. So what you really want to do is pick funds that have dissimilar price movements, funds that are going to react to different economic events around the globe in different ways. So US versus non-US funds, large versus small, value versus growth, all these different factors of funds respond to different economic factors differently. Together they're going to help decrease the volatility of your portfolio and as a result increase your returns.
