How to Pick a Great Mutual Fund

Here's an interesting piece on how to pick a top-performing mutual fund. The summary:

A new study reinforces time-tested advice for investors shopping for mutual funds: Look first for funds with low fees, then go from there.

The study concluded that investors should make expense ratios a primary test in fund selection, because they are still the most dependable predictor of performance.

Ha! I'm sure this will get a few people riled up! ;-)

In particular, someone is bound to say, "Forget about costs -- you should consider performance before anything else."

I'm assuming they mean "performance net of costs", which is something I'm also interested in. The only problem is that performance is difficult to judge in advance, costs are not.

In fact, Morningstar, the company that rates the performance of mutual funds, even has a hard time picking funds that out-perform a simple "low cost fund" strategy:

Morningstar's star system measures a fund's past performance while weighing how much risk a fund took to achieve its returns. For example, a fund that produced far-better-than-average results over 10 years won't necessarily secure a top rating if its performance was unusually volatile during that period.

Fund expenses are a slightly more important factor in predicting how well a fund will perform than the one- to five-star system that Morningstar uses to rate funds, the company said in a study it published in August.

Ha again!

As I wrote four years ago, costs matter if you want to maximize investment returns.

And for those of you interested in how I invest, I'm still putting the majority of my money into these funds.

Comments

[Eugene Krabs]

Oh yeah, this entry should be interesting.

I've also stated in the past that I'm of the opinion most people should just buy low cost index funds as well.

Come to think of it, so does Warren Buffett:

http://money.cnn.com/video/news/2009/05/07/news.buffett.050709.cnnmoney/

And again, this is for the average individual who just wants to invest for their future. For the rest of us who are much more interested in this subject matter, then feel free to do something different.

Still though, there have also been studies that prove it's very difficult, even for professionals, to out-perform low cost index funds. Here's an example comparing DFA's well-regarded managed funds versus equivalent Vanguard funds.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1504756

I've spoken with Prof. Ed Tower, the author of this white paper before, and his conclusion is that, as good as DFAs are, they still do not out-perform Vanguard index funds in net return.