How do I evaluate a mutual fund?

Learn how to evaluate mutual funds and find the right one for you.

Tutorial

A mutual fund is an investment account which pools several individuals and institutional money to be invested by a professional money manager. A mutual fund can invest in stocks, bonds, cash, options, commodities, or money market securities. Typically, a mutual fund specializes in one type of investment - for example, large company stocks, international companies, or bonds.

The first thing to look at when investing in a mutual fund is the type of investments it is making. At a large mutual fund company, you will find mutual funds which invest in "large cap" - large companies - "small cap" - small companies - all the way down to bonds and cash. Your expected return will be lower for the safer investments like bonds, money markets, and currencies and your expected return is higher for your higher risk investments like international firms or small cap companies. You should know the level of risk you are willing to accept and only invest in a mutual fund which meets that level of risk.

The second thing to look at in a mutual fund is the historical returns of the fund. A mutual fund which has been operating for several years will provide the lifetime returns (gain of an investment), and then a set of numbers over the years. For example, a mutual fund that has been operating for 12 years will typically provide you a lifetime return, a 10 year return, a 5 year return, a 3 year return, and the return from the previous year. You can then judge the mutual fund on how well it has performed over its existence.

The next thing to check a mutual fund on is its operating expenses. A mutual fund has an expense ratio - the percentage of the mutual fund which is used for operating expenses. This is typically a small number but does cut into your return. For example, if a mutual fund has a 0.75% expense ratio and a return of 6%, you will only see 5.25% of that return.

Load and No Load. There are two general types of mutual funds: load and no load. A loaded mutual fund either charges you a percentage of your investment when you investment, a percentage of your withdrawal when you withdraw money, or both. For example, a loaded fund may take 2% of your money when you invest. You typically see loaded mutual funds sold more by money advisors than a normal person would purchase on the open market.

A "no load" mutual fund does not charge you an entry or exit fee.

Once you have reviewed all of these attributes about a mutual fund, you should be able to make an educated decision as to which mutual fund you should invest in.