|
Picking Top Mutual Funds
Picking Top Mutual Funds
Finding the top mutual funds can sometimes be tricky. You can read about the top mutual funds in magazines or hear about top mutual funds from friends. But, is there a systematic way to pick the top mutual funds?
Over many years the stock market indexes have gone up. Of course, looking at any year some indexes have gone up while others have gone down. But, the overall long-term trend is up.
Market indexes tend to indicate the average value of a group of stocks or bonds. Some market indexes track larger "blue chip" companies while other indexes track smaller companies. There is a market index for just about any market sector you can think of.
These market indexes track the value of a selected set of companies. For example, the Dow Jones Industrial Average comprises 30 large, widely-held companies. The NASDAQ-100 Index includes 100 large, non-financial companies that are listed in the Nasdaq stock market. The composition of such indexes remains fairly consistent from year to year.
Managed mutual funds often concentrate on a particular market sector. But, the financial securities (stocks, bonds, and other financial instruments) held by managed funds may change on a daily basis. The objective of these funds is to produce an ever increasing asset value for the fund investors.
It is fairly typical that 80% of mutual funds do not increase in value faster than their market indexes. One reason for this are the fees associated with managing a mutual fund. The management team must be paid, so there is a management fee--often around 1% of total assets. Another fee, usually not reported, is a trading fee. It costs money to buy and sell stocks, bonds, and other financial instruments. The trading fee may be 3 to 6% of a fund's assets.
Because of these fees, a managed fund must actually beat the market indexes by 4 to 7% in order to just break even. And thus, in any given year to total return of around 80% of managed funds fail to exceed the market indexes.
However, there are some top mutual funds whose performance over a number of years exceeds that of most market indexes. These top mutual funds are not simply one year wonders, but have a proven record over a number of years.
There are a number of ways to pick top mutual funds for your investments. I will describe the way I typically pick the top mutual funds I use for my investments.
I typically choose a diversity of top mutual funds whose historical performance exceeds the category averages, with a management team in place who produced those results. I then re-evaluate my selection of top mutual funds every 3 months.
First, I find potential top mutual funds. Here I use the Morningstar Fund Selector.
The Morningstar Fund Selector allows me to choose a diversified group of funds. With each search I can select the fund group (domestic stock, international stock, taxable bond or municipal bond), and the Morningstar Category to further diversify the top mutual funds I want to hold.
I will typically choose funds with a manager tenure greater than or equal to the industry average. You don't want funds with a new and unproven management team.
I choose no-load funds since I don't see any reason for paying a sales charge on top of what my brokerage firm charges for my transaction. And the return of top mutual funds does not in any way depend on a sales charge.
I then choose a Morningstar rating of four or five stars with a risk better than average.
For rates of return I select greater than or equal to the category average for the YTD, 1, 3, 5, and 10 year values. Sometimes these requirements do not find any funds. If that happens I return the YTD return to "any".
Then I select "Show Results" at the bottom.
This results in a list of top mutual funds in a certain market sector that are good candidates for my investment.
I transfer some of the top mutual funds to a spreadsheet.
To get the 1, 3, 5, and 10 year total returns you can click on the name of the fund, then click on the "Total Returns" menu item along the left hand column. I enter the values in my spreadsheet.
After doing this for a number of fund groups and categories I am ready to pick the top mutual funds I want to invest in.
Using the 1, 3, 5, and 10 year average rate of returns I create a weighted average of these values. You can simply take the average of the four values which gives equal weight to each value.
I give added weight to the 3 and 5 year returns. This helps select top mutual funds that have performed well for a number of years. My formula is as follows:
( 1-yr + 2 x 3-yr + 2 x 5-yr + 10-yr ) / 6
This formula basically says that I think the 3-yr and 5-yr rates of return are somewhat more important than the 1-yr and 10-yr rates of return. You can choose any formula you want, but this is what I use.
Then I sort the results by the weighted average. The top mutual funds are good candidates for investments.
Every 3 months I enter the latest values for the 1, 3, 5, and 10 year rates of return into my spreadsheet. I also look for additional funds with the Morningstar Fund Selector.
Then I sort the spreadsheet to see if the funds I selected remain near the top.
If one of my selected funds looks like it's rate of return is declining too much, I sell that fund and purchase another fund.
Over the last 20 years or so I have found this technique to be effective in helping me pick top mutual funds and invest successfully.
I would be interested in learning of your success with this or any other system you use.
Resources
| 