Anyone who wants to know how to choose the right investment fund is in the right place. In the following guide, I have compiled all the important information needed to quickly assess and select the mutual fund that best serves your personal investment objectives. Mutual funds are available in many variations and with a variety of fees, so it is important to have all the important information on the list before deciding
An investment fund allows one to own a whole basket of different stocks by simply owning one share of the mutual fund. Mutual funds are “actively managed” which means that each mutual fund has a manager whose job it is to select stocks for inclusion in the fund and to try to beat the benchmark (usually an index of some sort – such as the S & P 500 or Russell 2000). In return for the immediate diversification of a mutual fund and access to a (hopefully) dominant strategy, you pay a management fee.
Mutual funds offer some advantages to private investors. Immediate diversification. As mentioned earlier, holding one share of an investment fund equals a large number of different companies. This helps to hedge the portfolio and ensures that you are not too dependent on the success of a particular stock.
Time savings. If you invest in an investment fund, you do not necessarily have to track individual stocks – after all, you pay the fund manager for it. For a beginner or someone who does not have much time, that’s a big advantage. Anyone who does not have time, at least a few hours a month, to learn about the stock market, is well advised to invest in a mutual fund.
Possible out-performance. The managers of mutual funds aim to beat the market – they want to prove to the investor that they are worth every penny of their management fee. Indeed, some mutual funds are beating the market and allowing investors to reap the rewards of fund managers’ efforts.
Of course, no investment vehicle is perfect. Mutual funds also have their disadvantages. High fees. Investment funds generally charge significantly higher fees than index funds or exchange-traded funds (ETFs). We will discuss fees in more detail below, but keep in mind that the average cost ratio of the actively managed equity fund is 0.78% of assets under management, while actively managed bond funds average 0.55%. At least that’s what the Investment Company Institute found out in 2017. By contrast, equity index funds and bond index funds have a cost ratio of 0.09% and 0.07%, respectively.
Historically considered under-performance. Over 90% of equity funds have lost value over the past 15 years. (Bond funds have performed slightly better, but the mixed average is still 82% of actively managed funds that are outperforming their benchmarks, with most investors paying more in most cases than index funds … .only losing to the market.
Tax inefficiency. Managed investment funds often buy and sell stocks. These sales – measured by fund turnover, ie the value of assets purchased or sold during the past year as a percentage of the total net asset value of the Fund – result in chargeable events, such as the sale of stock. Capital gains taxes can erode investment gains. Managed funds allow investors to pay these taxes. Anyone who does not invest in a tax-privileged account could pay additional taxes every year.
The expense ratio is the annual fee that an investment fund charges an investor to park money in the fund. The expense ratio covers the administrative costs and salaries of the fund’s employees, and what’s left goes as a profit to the parent company. The expense ratio is typically around 1% of assets under management or less. That may not sound like much, but imagine that you would have invested 20,000 euros in an equity fund with an average cost ratio (0.78%) and an annual return of 7% over 30 years. These 20,000 euros would grow to 120,370 euros – not bad! but in the meantime, 13,587 euros will be charged as fees. Furthermore, every euro you pay in fees is one euro, which was not 7% a year, So those fees would cost another 18,288 euros in missed returns. This is a total of 31,875 euros in yields, which are lost in fees at the end.
This fee is usually part of the expense ratio and specifically represents the money spent on the marketing of the fund. It is not linked to fund returns or anything operational; it only helps the fund to raise more money.
This is a charge on the initial investment in a mutual fund, which means you need to invest less money in the fund. In the example above, a 2.5% initial charge would reduce an initial investment from $ 20,000 to $ 19,500 (because buying into the fund would cost $ 500), and the final balance would drop to $ 117,361 because it would sacrifice part of the compound interest Has.
Sure: back-end load means fees that are charged when you sell the mutual fund. Typically, a mutual fund has either front-end load or back-end load charges – rarely both. So let’s take the 20,000 dollar example without a sales charge. If you sell after 30 years, the back-end charge would cost an additional $ 3,009 in fees and reduce the stake to $ 117,361. This is exactly the same cost as the initial charge because 2.5% of the total in advance or 2.5% of the total at the end means a reduction by the same amount.
A deferred load is a form of back-end load that calculates the equivalent of a front-end load. It is calculated when you make the initial investment but defers until you sell the fund. For example, a deferred load of 2.5% would cost 500 euros for an initial investment of 20,000 euros, even though this investment has since grown to 120,000 euros. (And you pay only once you’ve sold the fund.) While all fees have an impact on return on investment, a deferred load has less of an impact than similarly sized sales fees.
Again and again, a concept will jump in the eye, which I define below. You have to know that if you want to find the right fund for you.
Fund prospectus. In the prospectus of an investment fund, you will find all the necessary information that you need to know before investing. It is usually available online and should help to select the investment fund that is suitable for the personal investment objective. Personally, I tend to seek funds with large historical returns, low portfolio turnover (which I define below), and minimal fees. The prospectus also provides insight into fund risks, which can give you valuable insights into the different ways in which the hypotheses that you set up in advance can all go awry.
Managed assets (also assets under management, AUM). AUM describes the total value of the fund in terms of how much money investors have invested in the fund. That’s important to know. For even though huge funds do not automatically mean great investments, small funds are sometimes small for good reason. A small AUM figure – below $ 1 billion – should usually be seen as a sign that you are still looking a bit left and right before deciding to invest.
Inflows and outflows. Mutual funds earn their money by charging fees based on their AUM so they have the incentive to increase the AUM. This is done in two ways: increasing the underlying NAV of each stock by selecting the winning stocks, and by getting more and more investors into the fund. The latter is referred to as “inflow”, ie the inflow of a fund. In contrast, a fund that is in difficulty or has lost investor confidence has “outflows” or a net loss of capital (measured in dollars).
Portfolio turnover. Portfolio turnover is a measure of how often a fund buys and sells securities (usually stocks). The actual calculation is the number of new shares bought or sold (whichever is lower, the numbers will generally be similar) divided by the NAV of the fund in the last 12 months. It is expressed as a percentage so that a fund with a portfolio turnover of 75% has replaced three-quarters of its investments in the last 12 months. Higher turnover means a higher tax burden at the end of the year and also means that the fund will generally hold securities for a shorter period. Here at The Motley Fool, we prefer funds with lower turnovers, as this means the fund manager is thinking longer term (leading to better long term fund performance).
Many investment funds require you to invest a minimum amount when you want to buy stocks. Investing less than this amount will often incur additional fees. Since a fee can break the returns, it makes sense to buy a fund, if you can afford the minimum requirements.
Many mutual funds offer several variants of the same fund, giving them the opportunity to acquire different classes of shares (usually class A, B, C or I shares). Look carefully at the fee breakdown for each class before deciding which one to buy. The share classes do not indicate a difference in the investment philosophy or the quality of stock selection; the only difference is the fees and who can buy them. “I” stands for “institutional”, so that this class is usually not accessible to the retail investor. FINRA, which regulates brokers selling mutual funds, has an excellent fund analysis tool that helps you better understand which class is best for you.
Now that we’ve discussed the basics, let’s take a look at how to invest in mutual funds. In the end, you’re there to earn money, so we put that to good use from a perspective.
1 Clarify the investment objective. What do you want to achieve? Do you want to triple your investment and take some risk? Then consider a small-cap fund that uses the Russell 2000 as a benchmark. Receive capital and generate income? A pension fund may be your best bet. Dear income and capital growth? A stock-based dividend fund might make sense in this case.
2 Define the time horizon. The time you want to get the money to work for you is important: the longer, the more effectively it uses the compounding. Here at The Motley Fool, we generally do not believe in investing money with a time horizon of fewer than three years – and most of us plan our time in the market in decades, not months or years. The reason is simple: markets go up and down, often fiercely, over weeks, months and years – but over decades there is a slow but fairly steady climb.
3 Reduce fees (and avoid high fees). As the above examples have hopefully shown, fees are the biggest enemy of the return on investment. If an investment fund charges sales of some kind, you should stay away. (Remember, no-load funds do not charge these fees.) Also, avoid funds that demand much more than the 0.78% average cost ratio for equity funds. Here at The Motley Fool, our general rule of thumb is that you should not pay more than 1% of the invested assets per year in fees. High-cost ratios and revenue burdens are incompatible with this rule.
4 Look at the historical returns of the fund. The other big enemy of investment returns is, well, bad investments. Fortunately, the fund prospectus shows the performance of the fund in the past compared to its benchmark. Has the fund underperformed in the last five, ten and 15 years? If so, there are hundreds of others to consider. And if the fund has not been running for at least five years, I would be particularly suspicious. Finally, historical performance helps you to understand how the fund is performing in good times (like the 2009 bull market) and bad times (the Great Recession). You want a fund that has shown that it can do well in both market segments. Also, consider review the returns after deducting fees and compare them with the benchmark; this will help one to understand if the fund performs better even after deducting the additional costs. If this is not the case, you look for another fund (and consider passively managed index funds as a possible alternative).
5 Strive for lower fund sales. As mentioned above, lower turnover means that the fund manager has a longer-term focus, and it also reduces the tax inefficiency of the mutual fund. This is a win-win situation. I personally avoid funds with an annual turnover of more than 20%: fund managers who try to time the market tend to under perform.
6 Meet the fund manager. An investment in an actively managed mutual fund is also an investment in the fund manager. These are people – including careers, successes, and philosophies. One should be informed about the people behind the fund and make sure that this is someone to whom you want to entrust your money.
7 Invest in mutual funds. If you have found a mutual fund that meets all six of the above requirements, then you might have found the right one. The rest is pretty simple: if you have an online brokerage account, sign up and place an order for the majority of the fund you want to buy. You receive shares based on the closing price of the investment fund on that day.
Well, since you bought a mutual fund, you can sit back, right? Not correct. You should check at least once every quarter that everything is going well. It should be kept in mind that even the best stock pickers are off the mark from time to time, so the poor performance of a quarter should not necessarily end the relationship with the fund. But if that turns into a trend, you have to act.
Compare your own funds with others – how are they developing? This helps to understand if the entire industry is experiencing problems or if the manager is at fault. And if one fund is far above the others, and has proven so many times in the past, then you should think about buying into this fund.
But if you’re having trouble finding a mutual fund that outperforms its benchmark index after deducting fees, you should think about whether an index fund or an ETF is the better investment. They will not outperform the benchmark, but at least bring the right performance. And given the historic market return of around 7% per annum, that could be good enough in the