How to pick up a Mutual fund?The following explanations are intended for clarifying thoughts on how to screen and pick mut...
invest their own money in it. So that could “reassure” you they may think twice before entering riskyinvestments. Expense ...
Whenever a mutual fund distributes incomes or capital-gains to its shareholders it taxes them. Thatcould be painful especi...
The apparent advantage from having an advisor is that he could monitor the performance of your fund,give you advice in whe...
Lower your feesFees in mutual funds can be broken down into two main categories: one-time fees and ongoing annualfees. Whi...
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Bfm howti pickfund_old

  1. 1. How to pick up a Mutual fund?The following explanations are intended for clarifying thoughts on how to screen and pick mutual funds.However this document is not destined to dictate how to invest but to give insights about what may beimportant to look at when one wants to invest her money in a mutual fund.In this financial distress, you cannot have missed the recent tales about the downfalls of top-performance fund shops, the management scandals and the huge risky bets that cost investors theirretirement savings.For that reasons, investors have never needed so much advice from professionals about how placingtheir money.Before parting your money in a mutual fund, it is important to ask yourself: What is the fund’s strategy?How does the fund manage its risk? Do I consider a long or short-term placement? Or, who is runningthe fund?Understanding the company where you place what could be your children’s future tuitions isfundamental. For that matter, there are valuable documents issued by the funds that you should readcarefully to know where you will step in: the prospectus, the Statement of Additional Information andthe annual report.Those documents are usually published on the firm’s website. They could be hard to understand forsomeone who does not have a background in finance as they are full of boilerplate information (most ofthem required by the SEC) but they contain vital information.The prospectus:It states how you could become a shareholder (how you could open an account), what is the minimumamount of money required, how you could buy or redeems shares.It also contains information about: - The Objective: Long or short term investment? - The Strategy: What are the instruments the fund invests in? Bonds, Stocks (value/growth), Cash… - The Risks: What are the markets the fund targets? Emerging or developed stock markets, corporate or government bonds. - The Expenses: Does the firm charge with one-time fees or/and ongoing annual fees? Who are those taxes destined to? - The Past performance: What are the historical returns? Even though past data are somewhat useless to predict future performance, it could give an idea of the company’s consistency over time. - The Management: Who is running the company? Board of directors, fund managers…The Statement of Additional Information:This is an extra document that can be requested and provides with interesting information such as whowill represent your interests in the board of directors, how much do the shareholders pay them and alsohow much these directors own of the fund. It is sometimes a good thing to select funds where managers ©Bourbon Financial Management
  2. 2. invest their own money in it. So that could “reassure” you they may think twice before entering riskyinvestments. Expense fees are also more detailed in the report.Annual report:If you have more knowledge in finance then you can read through the annual report where the latestfinancial statement is provided. Footnotes could also be useful to know how the company hedges its risk(derivative strategy) and you can also look more closely over the past returns (how does the companybehave compared to benchmarks).Nevertheless, one should not just stop there.After having analyzed those documents, it is sometimes useful to call the fund and ask for morequestions if any.Trackers institutions or third-party sources like Morningstar help investors monitoring funds. They areusually neutral and expose clear data that could be intentionally hidden or blurred by funds. They alsocompare firms between themselves and that gives you an idea of the fund’s performance relative to themarket.What are the important things to look at when you screen for a mutual fund? Prefer the total return to the NAV as the firm’s performance proxyThe NAV changes every day and could be misleading. Indeed a small NAV does not mean the firmperforms badly or shareholders lose money. The NAV decreases each time the mutual fund distributesmoney (income or capital-gain) but the fund is none poorer. Let us take an example to be more precise.If a fund has a NAV of $10 and let assume it distributes $1 as an income. You should know that each timea mutual fund gains money, it has to pass it along to its shareholders (minus the managers’ fees). In thissituation the NAV slips to $9. But the shareholders’ wealth has not changed. They still have $9 investedand $1 in cash (they can also reinvested this income in the fund. In this case, the fund will buy moreshares which will increase the NAV).In order to assess the performance of a mutual fund, prefer to use the overall return as the NAV is veryvolatile. Consider trailing returns as they are calculated every day and are more relevant than calendaryear returns. Select at least the 5 year returns and ignore shorter timeframes.Screen for mutual funds that have market beating historical returns in the hope that they will continuetheir winning ways. For that reason, you should look at positive alpha relative to the benchmarks. Avoid over taxationMutual funds are easy to enter. You can buy or sell your investment at any time as you are not requiredto find a counterpart to which you can buy or sell your instruments. The up-front payment is bearable asyou can join a mutual fund with $1000. They are professionally managed and regulated. These havingbeen said, one should be tempted to ask what are the downsides? Mutual funds are heavy taxers.How could you minimize the tax impact? ©Bourbon Financial Management
  3. 3. Whenever a mutual fund distributes incomes or capital-gains to its shareholders it taxes them. Thatcould be painful especially if you just joined the fund because you are paying taxes for gain you do notbenefit. In addition, firms can also pay out capital-gains even though they experienced a loss during thepast year (yields are generally paid out at the end of the year). In other words, you could still lost moneyin a fund and still have to pay taxes (that can be illustrated from technology funds which made capital-gains distribution while they were in the red in 2000).To avoid that one could ask a fund company if a distribution is imminent before buying a fun. The bestway to figure this out is to directly call the fund’s toll-free number.Also search for low-turnover funds. That means the company does not do many sell/buy transactionsand therefore is unlikely to distribute taxable capital-gains. Screen for funds that have a turnover lessthan 10%. These are said to be tax-efficient.Favor funds which have their own managers’ wealth invest in these funds. They may be tax-conscious.Besides, if you want to invest in bonds, try municipal bonds as these funds are low-taxed or tax-exempt.Being tax conscious could be important because regardless the performance of the firm, what matters iswhat you keep, not what you give away. Consider the economy as a factorConsidering the state of the economy is a parameter to include in your screening factors. In a period ofrecession, one can favor investing in small-cap growth stocks funds as they perform better than large-capvalue ones. Also, investing in bond could not be the best thing to do as well because in harsh economictimes, bond yield is low.So consider the present economic pattern and ask yourself what sort of strategy the fund employs. Need someone to help you find the good funds? Load fundsInvesting in a mutual fund could appear overwhelming. Instead of having one stock, one ticker, oneexchange you have suddenly a whole diverse portfolio. And maybe you do not have either the time orthe knowledge to scrutinize funds by yourself. In this case, you may need help to find a suitable mutualfund.Financial advisors or financial planners could help you doing that. Of course, their services are not free.They may request an up-front fee or a percentage of your investment money. Or they may forgo a feeand earn a commission by investing your money in what are called Load funds.A load is a charge deducted from your investment when you buy or sell shares. Note that this charge isnot intended for the fund manager but for your personal advisor. Therefore, it is different from themanagement fee (which you will also have to settle).However, some advisors charge you with both fee- and commission-based. ©Bourbon Financial Management
  4. 4. The apparent advantage from having an advisor is that he could monitor the performance of your fund,give you advice in when to sell/buy or redeem your investment if necessary and take care of thepaperwork. You also have to make sure that your advisor has you understand what she is doing. In somesense, she has to teach you about investing. And also make sure that your interest goes before hers.Indeed, it is your money after all so you need to understand why it is invested in this way.The obvious disadvantage is that these types of services are costly. So ask yourself if you really needthose. But if you really have no idea about how a fund works you should better take someone to helpyou (even if you have to pay extra) than take the risk to invest by yourself and risk to lose yourinvestment.On the other hand, if you do not need investment advice and feel like you have time and interest tolearn in funds, focus on no-load funds (also termed fund families) as it is pointless to pay for a serviceyou do not benefit. Fund families do not charge any sales commissions.If you choose to invest in fund families make sure to select a large one. One of the main reasons is thatthey are well-diversified which mitigate your risk. They offer stock and bond funds, domestic andinternational funds, large- and small-cap funds or growth and value funds. Being a shareholder of a fundwithin a fund family allows you to transfer your assets from one fund to another.Besides, if you could really dedicate times to your investment, another way to diversify your portfolio isto invest in what is called a “supermarket”. A supermarket gathers different fund families. Supermarketsdo not charge you when you invest in a fund through their programs. But instead they charge the fundsincluded in their programs. And not surprisingly taxes charged by the supermarkets to the funds arepassed along by the funds to its shareholders, which means to you. Those taxes are buried into thefunds’ expense ratios and range from 0.25 to 0.40% of funds’ assets per year. So even thoughsupermarkets offer a wide range of fund families which help to diversify your investment it is also moreexpensive. Consider Third-parties sources ratingsThe ideal fund would deliver market-beating returns with minimal price swings. Morningstar’s Star ratingcompares a fund’s historical return to its historical volatility. The rating ranges from 0 to 5. Mutual fundswhich have the higher return/volatility ratios earn 5 stars. While it does not guarantee the futureperformance of funds, it could be a good starting point. Therefore, screen for 5 –star funds. Consider the manager’s tenureHistorical performance is meaningless if the fund manager responsible for the results is no longerrunning the fund. Check the manager start date and rule out funds that are ruled by someone in placefrom less than 5 years ago. ©Bourbon Financial Management
  5. 5. Lower your feesFees in mutual funds can be broken down into two main categories: one-time fees and ongoing annualfees. While not all the funds levy one-time fees, they all charge for ongoing annual fees.Examples of one-time fees could be redemption fees or maintenance fees.Redemption fees are applied to deter market-timers from moving in and out of the fund. Those short-term investors could penalize long-terms investors in a sense that as they scrutinize the market the sameway, they see opportunities at the same time and then all cash out their investment at the samemoment. That could force fund managers to sell stocks that went up. If so, the fund would thereforedistribute capital-gains to shareholders and of course charge the shareholders (income tax).Maintenance fees are levied by some funds which impose a minimal account balance. If an investor’sbalance goes below the maintenance margin then she will have to pay the difference.The ongoing expenses are usually charged by all funds and denote management fees, brokerage cost orinterest expense if the fund borrows money to buy securities.As you can see mutual funds are far from a free lunch but you can keep on what you earned by targeting“low-cost funds”. Incidentally, “low-cost funds” do not perform worse than “high-cost funds” so do nothesitate to screen for them.When it comes to fund bonds, the difference in returns between the funds are extremely low so everydollar that you pay for the fees could really hurt your return. Try to pick up bond funds with an expenseratio lower than 0.75%.Small-funds have generally higher expenses ratios because they tend to emphasize on doing researchesto keep up with “knowledgeable” bigger funds.Generally, try to avoid funds which have an expense ratio higher than 1.5%. Consider the risk you bearThe risk depends on the type of investor that you are and especially on your risk tolerance. The fundriskiness is also estimated by third-parties sources like Morningstar. Morningstar notably compares afund’s volatility to other funds in its same category (e.g. small cap, tech funds…) and among other thingsmeasures the volatility. Standard deviations rating run from 1 to 30. Risk-averse investors should avoidfunds with standard deviation above 10 and all investors should avoid investing in too risky funds (above15).It is also interesting to look at the statistic measure R-square. R^2 determines if the fluctuations of amutual fund can be explained by the index. R^2 tells you what proportion of a stocks risk is market-related. Nevertheless, when an investor buys a mutual fund different from an index fund, he expects thefund to over-perform the market (he buys the alpha) therefore a low R^2 is appropriate. ©Bourbon Financial Management