Is Your Mutual Fund Naughty or Nice?

As kids around the globe feverishly try to behave to ensure that they make the nice list for Santa Claus, us adults feel like we don’t have to worry and can play it cool. Not so fast. Your investment might be on the naughty list. Save yourself from a lump of coal: review your mutual funds and access whether they make the nice or naughty list.

Unchecked asset growth

Many fund managers admit – off the record, of course – that the bigger the fund, the more difficult and costly it is to buy and sell stocks. Another problem is that some funds are so large that investment options shrink as the fund is forced to buy larger companies to keep its growing asset base at work.

What should you do?
Look for funds run by families that have closed their doors to new investors once the fund became too large. Also, keep you ear to the ground for funds that publicly state they will close their funds to new investors if the fund size reaches a specific level.

Runaway expenses

Check your mutual fund expenses. Many mutual funds pass on the cost of marketing, distribution and management expenses to their shareholders.

What should you do?
Refuse to purchase high-expense funds and set a limit on the fees you are willing to pay. While you should not pick a fund based entirely on lowest fees, expenses should be a factor. Look for a large-cap mutual fund with expenses less than 1% or a small-cap or international fund less than 1.5%.

Insincere communications

Funds are required to manage shareholders expectations responsibly. They should provide balances commentary on the fund’s performance. Sadly, many companies do not take this responsibility as seriously as they should.

What should you do?
Make sure you read the letter from management in the annual report. The letter will give you a feel for whether management is driven by concern for marketing or concern for shareholders. I like to see management admit mistakes and control expectations.

Those companies that live up to their fiduciary responsibility to protect their shareholders’ interests should be rewarded, while the others will get the message if you vote with your feet and leave.

Visit http://www.morningstar.com for full access to mutual fund analytics.