Prerequisites: Weakon 205 & Weakon 235
I’ve already established a mutual fund is essentially a company you buy shares in that invests money for you. The mutual fund can be made up of any combination of stocks, bonds, and other investments like futures, options, real estate and so on. The advantages of mutual funds far outweigh the disadvantages, especially when you realize a mutual fund manager is a much more disciplined investor than you are.
That being said, how do you pick a mutual fund? What are the types of funds? How do mutual funds make money? That manager isn’t working for free you know. I’ve already told you about Morningstar.com. What I haven’t introduced yet is their style box for mutual funds – picture.
The style box is their method to classify a mutual fund, making it easier to compare apples to apples. Starting with the northeast corner we have large-cap value stocks. Value stocks are considered undervalued by the market, they are often dividend stocks in which profit growth is potentially limited. Moving to the northwest we have large-cap growth stocks. These are stocks that give little dividend (often none) and so returns to the investor rely only on capital appreciation. Profit is often not a guarantee and price changes can be rapid. Google is a large-cap growth stock. At due north we have the Large Cap Blend. If you own a S&P 500 Index fund it would fit in this category. That doesn’t mean all blended funds are indexes, far from it in fact. I could have a blended fund of technology stocks so make sure you compare apples to apples. The row below the large-caps are the mid-caps. You’ve probably heard of many such companies that are mid-caps, but most are either smaller or regional players. The bottom row is small-caps, unless a specific company is in your neighborhood to in the news, you’ve never heard of it.
For the rest of this piece I randomly chose a mutual fund that I do not own. Its not important what they are invested in, I’m just going to show you the important information that can be obtained on a mutual fund site like Morningstar.com.
I picked the Stratton Multi Cap fund (ticker symbol: STRGX). I recommend you open another window or tab and view this post and the page side by side. A good starring point is the Morningstar rating. This fund has 5 out of 5 stars meaning the analysts at Morningstar generally like this fund. This does not make it a definite buy, but its a start. Also available are the total assets in the fund. This is how much money is currently in the fund, mostly from other investors like yourself. STRGX is not large at just over $140 million. This is good because the big big big funds are so fat that their investment choices can actually influence the market. Look at what happens whenever Warren Buffet talks about a company he doesn’t own. The NAV is Net Asset Value, which is the value of one share in the fund. It’s not all that important because you can’t compare it to anything.
STRGX is a no load fund. This means there is no charge on the purchase or sale. I avoid loaded funds at every corner because they are big rip-offs. You often pay 5%+ just to buy the fund. That’s 5% of your money GONE forever. Sometimes you’ll see back-end loads designed to keep you from selling the fund. Generally they expire after about 5-7 years so I do not frown on them as much, but I’m yet to find any loaded funds that are better than a no load.
Loads aren’t the only way the employees of your mutual fund make money. The most common and accepted practice is the expense ratio. This is what you pay each year to keep you money invested. STRGX is 1.06% of your assets, too rich for my blood. Index funds can have fees as low as 1/10 of 1% or 0.1%. Remember this eats into your earnings so minimizing expenses is critical.
Conservative investors will often take note of the tenure of the fund manager(s). Looks like the guy that started this fund is still the manager after 36 years. Incredible! I usually look for at least 5 years experience with the fund, but in the case of an index fund less time is fine.
Moving down the page further reveals the details of the fund. I see what industries the fund is invested in and what their top holdings are. Take notice this fund is heavy on energy, and has actually made money in 2008, unlike most funds. The turnover figure is a representation of how much these balances change over time due to trading. 26% turnover means a year ago 74% of this fund’s holding were the same. It is possible to have greater than 100% turnover; trading requires fees, which you must pay. Score another one for index funds as their turnover is often much less than 26%. I choose funds with less than 10% as a rule of thumb.
I generally do not give out specific investment advice. Many website already give good advice and you’re smart enough to make your own decisions. But DO NOT make your investment choices based on the stat sheet on Morningstar. Go to the websites of the funds and download the prospectus. It contains all the legal spiel and a detailed outline of how the fund operates. They also, by law, must include a statement of fees. There are other fees beyond the loads and expense ratio. The prospectus is the single most important document for a mutual fund, if it doesn’t make sense to you, you shouldn’t get into that fund. This is how many folks end up in bad funds that lack transparency.