How To Evaluate And Select Mutual Funds.
Investors can use mutual funds to build wealth over time. A mutual fund is an investment that pools money from individual investors and invest it in a diversified portfolio. Compared to stocks, mutual funds offer investors more diversification and less volatility. But how do you evaluate a mutual fund? Here are just a few basic things to take into consideration when selecting mutual funds for your portfolio.
There are many factors to consider when selecting mutual funds to invest in. Without further delay, here are 6 of the many parameters to take into account.
1. Mutual fund's performance
A mutual fund's performance can give you a good idea of a its financial health. We typically look at a fund's performance over the last 1 year, 3 years, 5 years and 10 years. A fund with a consistent, acceptable or solid performance is one we would feel comfortable investing in. Also, we look at a fund's performance for the current year (YTD performance).
2. Expense ratio
The expense ratio is another important factor to consider when selecting a mutual fund. In very basic terms, the expense ratio tells you how much the fund charges annually to operate it, among other expenses. It is usually expressed as a percentage. For example, an expense ratio of 0.50% means that you pay $50 for every $10,000 you have invested in that fund. If you have $50,000 invested in that fund, you can expect to pay about $250. As you can see, it is prudent to select a fund with low expense ratios. Use this simple tool to estimate your mutual fund fees and expenses.
3. Minimum investment amount
Some funds require a minimum investment amount (e.g. $2500, $3000). This amount varies and depends on the broker, fund manager, investment strategy, among others. Other mutual funds have no minimum investment. We recommend a mutual fund with no minimum investment for any new investor, as you can start investing with as little as $1!
4. Overall rating and returns
You can evaluate a fund by looking at its overall returns and ratings. Funds are rated on a star scale, ranging from 1 to 5 stars. Returns are classified from low to high.
5. Net Asset Value (NAV)
The NAV or net asset value of a mutual fund is the dollar value of one mutual fund's share, excluding other fees. If the NAV of mutual fund X is $10.45, it means you need $10.45 to purchase one share of mutual fund X.
6. Mutual fund's top 10 holdings
A mutual fund is composed of a basket of individual stocks of different companies. Mutual funds can have anywhere from tens to several hundreds or thousands of stock holdings. The top 10 holdings of a mutual fund is usually listed to give you an idea of where the fund invests a good portion of its money in. This can give you relevant information about the mutual fund's financial health or investment strategy.
The bottom line
Investing in mutual funds is a good way to build a diversified portfolio and minimize risks. When selecting a mutual fund to invest in, there are many important factors to consider. For a novice investor, a mutual fund's performance, expense ratio, investment minimum, overall rating and returns, net asset value (NAV), and the fund's top 10 holding, among other things, should serve as a good starting point. An investor is encouraged to evaluate all the aforementioned parameters before selecting a mutual fund. Now that you have a basic knowledge about what to look for when evaluating a mutual fund, let's put it all together by looking at a specific mutual fund.
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