While it’s true that using mutual funds to invest in stocks and bonds is an effective way to put an investment strategy on autopilot, it is critical to analyze funds thoroughly to find those that match your investment goals.
The U.S. Securities and Exchange Commission (SEC) requires mutual funds to disclose ample information for investors to understand the fund’s investment objectives, principal risks, fees and expenses, and past performance of the fund. These are some important factors you should know before choosing to invest in a mutual fund.
However, data overload can be a problem in your analysis, which is why it helps to know a few of the least important factors in analyzing mutual funds, too.
The Least Important Fund Analysis Factors
In explaining the relative insignificance of short-term performance, it’s important to first emphasize that long-term performance can be an important factor in mutual fund analysis for actively managed funds. It can be a good sign if an actively managed fund turns market-beating performance over five or 10 years with the same management team in place.
However, the performance of actively managed funds over periods shorter than three years is less relevant. Investors should take to heart the warning stated in all mutual fund prospectuses that past performance is not necessarily indicative of future results.
Mutual fund rankings based on performance in the past year or two may make for interesting reading, but studies show that recent top performers frequently do not stay on top over the long term.
Net Asset Value
The net asset value (NAV) of a mutual fund is the fund’s total assets minus its total liabilities. It represents a fund’s market value expressed in a per-share amount, calculated once every day. The per-share value is the price at which investors can buy or sell fund units.
While the NAV does impact the decision of investing in a particular fund from a price point, it is in no way an indicator of the quality or performance of that fund. A high NAV or share price does not imply a better fund, which is why NAV isn’t a good sole indicator to judge a mutual fund.
Manager Tenure for Index Funds
This is a non-starter if you are considering index funds, which seek to track the returns of a market index, such as the S&P 500 or the Russell 2000. Because index funds follow a more passive investment style that doesn’t require the constant involvement of a fund manager, the tenure of a manager is not relevant.
A fund family is simply all the different funds managed by a single investment company. Some investors feel safer keeping their mutual fund investments within one family of funds because they view that company as more financially solvent or may perceive the fund brand as having a strong overall record.
Investors should know that fund company bankruptcies have been almost nonexistent. In building a portfolio of mutual funds, it is more important to find funds that match your investment objectives rather than to stick with one fund family.
One potential drawback of investing in multiple funds from a single fund family is that they share investment research and hold many of the same companies in many of their funds, so diversification isn’t as broad.
Fund Analysis Strategies You Should Follow
Understanding which factors do not need to be considered when analyzing mutual funds will help you focus on those factors that do matter, including:
Funds generally seek capital appreciation, income, or a combination of income and growth. You should consider funds that align with your investment goals.
A fund’s strategy is the approach the fund management team will use to decide which securities to buy or sell to obtain its objective. Again, you should judge how a fund fits in your portfolio based on its investment strategy given your financial goals and risk tolerance.
Every investment strategy involves some risk. The level of risk an investor is exposed to depends, in great part, on which assets it holds, how diversified its holdings are, and the overall risk of the markets themselves.
Fees and Expenses
Mutual funds pass along legal, accounting, and other fees to investors to cover the fund's administrative costs. Some funds charge a fee when an investor purchases or redeems shares. Fees and expenses can impact an investor’s returns, which is why it’s important to review the information on fees and expenses carefully in a fund’s prospectus.
An investment adviser and portfolio management team make investment decisions based on a fund’s investment objectives. Manager tenure is most important to know when investing in actively managed mutual funds. When analyzing a fund’s performance, it’s necessary to confirm the manager or management team has been managing the fund for the time frame you are reviewing and has had success.
ETFs Are Alternatives to Mutual Funds
Many investors have opted to invest in exchange-traded funds (ETFs). Like mutual funds, ETFs offer investors a simple way to build a diversified portfolio.
ETFs offer key advantages over mutual funds, including lower operating costs than traditional open-ended funds, immediate trading capability (as opposed to mutual funds that are bought and sold once per day), and tax efficiency.
Many of the factors that are important in mutual fund analysis are important in analyzing ETFs as well, including fees and expenses, investment strategy, and risk. Online brokerages often offer ETF screeners that can compare a handful of funds to help an investor find one that suits their needs.
- Analyzing mutual funds is vital to matching your investment strategy with the best funds.
- Knowing which factors are less important to analyze can help you focus on the factors that do matter.
- It’s tempting to chase after hot mutual funds with impressive short-term performance, but long-term performance (three years or even more) is generally a better gauge to pay attention to.