By Stacy Francis, CFP®, CDFA
Understanding where your investments are and how they behave is one of the most empowering steps you can take toward financial confidence. It helps you assess your risk, cost, and whether your portfolio still matches your goals.
Mutual funds are collections of different securities (stocks, bonds, and sometimes other assets) all managed together by a professional. But these funds aren’t all created equal, and some may be quietly hurting your long-term returns.
Below are four key questions to ask yourself to stay informed, in control and make sure that your mutual fund investments are aligned with your overall strategy.
Do you know where your investments are?
A survey of those who own mutual funds found about 40 per cent didn’t know the names of the funds they bought. Even if you are a pro when it comes to rattling off the latest mutual fund you purchased, you still may not have a clue about the mix of stocks, bonds and other investments. Sadly, mutual fund names don’t always tell the entire story. You have to dig deeper in the prospectus to figure out where fund assets are invested.
Your goal should be to create a balanced asset allocation with the mutual funds you won. Asset allocation is an investment portfolio technique that aims to balance risk and create diversification by dividing assets among major categories such as cash, bonds, stocks, real estate and derivatives. Each asset class has different levels of return and risk, so each will behave differently over time. For instance, while one asset category increases in value, another may be decreasing or not increasing as much. For most investors it’s the best protection against major loss should things ever go amiss in one investment class or sub-class.
What should you do?
Review fund fact sheets and prospectuses to see where the money is actually invested. There is no simple formula that can find the right asset allocation for every individual. You will need to assess your goals and risk tolerance to find out which asset allocation is best for you. Learn more about asset allocation here.
Does the mutual fund have 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 your 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.
How high are the mutual fund’s 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%.
How is the fund’s communication with shareholders?
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.
