We all know that mutual funds offer great benefits to investors. Professional management, low expenses, diversification, and liquidity are just a few advantages that make mutual funds so attractive. But how do you pick a few good funds out of the fifteen thousand or so that are available? Here are a few ideas to guide you through the myriad of information out there to help you make better investment decisions. You can find any of this information on www.morningstar.com or on MSN’s Money and Investing section at www.moneycentral.msn.com.
    The first thing you need to do is decide which category of fund you are looking for. Perhaps you are looking to replace an underperforming fund with a better one or even if you are building a portfolio from cash, your asset allocation will determine which type of fund you are looking for. This will narrow your search a little and also provide you with what is to be used as a benchmark to compare the fund against. When you are looking at US Large Cap funds, you should compare their performance with the S&P 500, when you are looking for US Small Cap funds, use the Russell 2000 index, and for international funds, use the MSCI EAFE index. Once you know what category of fund you are looking for it’s time to start sifting through the numbers.
    Everyone is interested in performance. A good long-term tack record is essential and although past results don’t guarantee future success, it’s the best indicator we have. Take notice that I said long-term…don’t chase after hot funds that did well last quarter or last year, they will usually let you down very quickly. Look for at least a three-year and preferably five-year history and compare that to what their respective index has done.
    Also, don’t shy away from the index funds just because you think you have to do better than the market. Most US Large Cap funds don’t perform as well as the index over the long run so indexing US Large Cap is actually an excellent idea…it’s also very inexpensive. Try the iShares Russell 1000 fund (symbol: IWB), or, Fidelity, Schwab, and Vanguard all have excellent S&P 500 funds. 
    Limit your search to only include funds that have a four or five star rating from Morningstar. Morningstar has been independently analyzing funds for over 20 years and you will get all of the information about each fund in their reports. This will include all of their fees, the top holdings, performance, and analyst comments.
    Manager tenure can be hard to tell sometimes because of job switching or newer funds with less of a history. You can usually read about the manager in the Morningstar report or in the prospectus, but you should definitely look it up. Look for managers with a decent history of a style similar to what they are doing in their current fund. Stay clear of All-Star managers who charge a premium just to have the privilege of investing in their fund. 
    Now let’s look at expenses. This is where most investors get confused and it’s usually because many firms don’t really want you to understand how much they charge on an annual basis. I know this may make some brokers upset but there are plenty of great no-load funds available and there is no reason to even get mixed up in the class “A” shares versus class ”B” shares debate. All of this just translates into how much the broker is paid that sold you the funds. The bottom line is you don’t need to pay for loaded funds if you don’t want to. Funds that have lower expenses also tend to perform better in down markets. All other things being equal, if the market goes down by 5% and one fund charges .75% and another fund charges 1.25%, the fund with lower expenses will have better returns. It seems small when you look at it one year at a time but when you add compounding over a 10 or 20 year period the differences can be significant. 
    Another area to look at when researching funds is their turnover ratio. This tells you how long they usually hold their positions. Lower ratio’s translates into less trading, less expenses and lower tax bills for taxable accounts. High turnover is usually more aggressive, more expensive and only appropriate for tax deferred accounts.
    One last item to go over is where you buy your funds. Most firms now have some sort of mutual fund super market that will have a few thousand funds available at no trading costs to you. This is an excellent way to invest in funds because you are not tied to any one fund family or group. If you decide to sell one fund and buy another you don’t have to open any new accounts or fill out any forms. You just sell one and buy the other, even if it is from a different fund family.
    You should expect to spend at least a couple of hours each quarter going over your portfolio. Although most people don’t spend that much time, your nest egg, your retirement, or your piece of mind is worth at least 8 hours per year. b