1. Do not Place Too Much Faith In The Star Rating From Morningstar – Some of the best mutual funds may not receive the best Morningstar rating, and even funds that get five stars from this company can still perform dismally in the future. Past performance and future performance are two different things, and the Morningstar rating system is only based on past performance. According to Morninstar fund research president Don Phillips the star rating should only be used to determine how well a fund has performed in the past, and should not be considered an indicator of how well a mutual fund will perform in the future.
2. Avoid Actively Managed Funds – A common myth is that the best mutual funds are those that are actively managed, and the facts do not bear out this misconception. The opposite is actually true, because as a whole actively managed funds tend to perform worse than those without active management. In addition active management tends to drive the cost of investing in these funds up so they are more expensive. Approximately 66% of funds that are actively managed will not meet the benchmark set, much less exceeded this goal.
3. The Facts Reported by The Fund Family Is Not Always The Whole Story – When the mutual fund families provide reports about the returns for the funds the family offers this information can be misleading. A large number of underperforming funds are liquidated or absorbed into other funds, and the initial fund basically disappears. Around 33% of actively managed funds will go this route, though this percentage is somewhat smaller for other funds. Investors may get glowing information about the successful funds that the fund family offers and the funds which did not succeed are not stated at all in the reports.
4. Expense Ratios and Turnover Rate Matter A Lot – The best mutual funds are those that have a low expense ratio and a low turnover rate. Funds that have a high expense ratio cost more for investors, and this cost is deducted from the investment return. A high turnover rate also means higher fees, because of the investment expenses involved whenever the fund buys or sells an investment. These costs are passed along to investors in the fund, and will result in a lower return on investment. A better choice is to pick funds that keep the turnover rate and expense ratio low, so there is more capital to compound and a larger future investment balance.
5. Load Fees Are Normally Unnecessary Expense – Some experts believe that the best mutual funds are load funds, but most experts agree that load fees are not necessary. A load fund charges a fee which is designed to cover the cost of the investment advice received, but some unscrupulous brokers will direct clients to load fees to increase the amount that the broker makes on the investment. Some load funds pay the broker for every investor directed to the specific fund. If investment advice is actually needed then a financial planner may be a better choice, and if this advice is not needed the load fee is a waste of money.