How to Measure Mutual Fund

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    How to measure mutual fund :-

    1) expense ratio:- It takes money to run a mutual fund. Things such as copies, portfolio

    management and analyst salaries, coffee, office leases, and electricity have to be taken care ofbefore your cash can even be invested! The percentage of assets that go toward these things themanagement advisory fee and basic operating expenses is known as the expense ratio. In short,it is the cost of owning the fund. Think of it as the amount a mutual fund has to earn just to breakeven before it can even begin to start growing your money.

    All else being equal, you want to own funds that have the lowest possible expense ratio. If twofunds have expense ratios of 0.50% and 1.5%, respectively, the latter has a much bigger hurdle tobeat before money starts flowing into your pocketbook. Over time, you would be shocked to seehow big of a difference these seemingly paltry percentages can cause in your wealth. Justflipping open theMorningstar Funds 500 2006 Edition sitting on my desk provides an

    interesting illustration. Take for example, a random chosen fund, FBR Small Cap (symbolFBRVX). When all of the fees are added up, the expense projection for 10 years is $1,835. Thisis the amount you might be expected to pay indirectly (that is, it would be deducted from yourreturns before you ever saw them) if you bought $10,000 worth of the fund today. Compare thatwith the Vanguard 500 Index which is a passively managed fund that seeks to mimic the S&P500 with its fees of only 0.16% per year and projected 10-year cost of $230 and its not hard tosee why you might end up with more money in your pocket owning the latter. Combined withthe low turnover ratio, which well talk about later, and its not hard to see how a boring low-costfund can actually make you more money than sexier offerings.

    2) avoid high turnover ratio:- Sometimes its easy to forget what you set out to do. Many

    investors simply think they have to get the highest return possible. Instead, they forget that thegoal is to end up with the most money after taxes. Thats why its hard for them to believe that

    they can actually get wealthier by owning a fund that generates 12% growth with no turnover

    than one that has 17% growth and 100%+ turnover. The reason is that age old bane of our

    existence: Taxes.

    Obviously, if you are investing solely through a tax free account such as a 401k, Roth IRA,orTraditional IRA, this is not a consideration, nor does it matter if you manage the investmentsfor a non-profit. For everyone else, however, taxes can take a huge bite out of the proverbial pie,especially if you are fortune enough to occupy the upper rungs of the income ladder. Itsimportant to focus on the turnover rate that is, the percentage of the portfolio that is bought and

    sold each year for any mutual fund you are considering. Unless it is a specialty fund such as aconvertible bond fund where turnover is part of the deal, you should be wary of funds thathabitually turnover 50% or more of their portfolio. These managers are renting stocks, notbuying businesses; such figures seem to convey that they are extraordinarily unsure of theirinvestment thesis and have little solid reason for owning the investments they do.

    3) Look for an Experienced, Disciplined Management Team

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    In this day of easy access to information, it shouldnt be hard to find information on yourportfolio manager. Its astounding that some of these men and women still have jobs despiteturning in horrific performance, they are still able to raise capital from investors who somehowthink the next time around will be different. If you find yourself holding a mutual fund with amanager that has little or no track record or, even worse, a history of massive losses when the

    stock market as a whole has performed well (you cant hold it against them if they run adomestic equity fund and they were down 20% when the Dow was down 20% as well) youshould consider running as fast as you can in the other direction.

    The ideal situation is a firm that is founded on one or more strong investment analysts / portfoliomanagers that have built a team of talented and disciplined individuals around them that areslowly moving into the day-to-day responsibilities, ensuring a smooth transition. It is in this waythat firms such as Tweedy, Browne & Company in New York have managed to turn in decadeafter decade of market-crushing returns while having virtually no internal upheaval. Anothergood example is Marty Whitman and Third Avenue Funds, the organization he built andcontinues to oversee.

    Finally, you want to insistthatthe managershaveasubstantial portion oftheirnet worthinvestedalongsidethe fundholders. Its easy to pay lip service to investors but its a differentthing entirely to have your own capital at risk alongside their's causing your wealth to grow, orfall, in proportional lockstep with the performance of your funds.

    4) Find a Philosophy that Agrees with Your Own when Selecting a MutualFundLike all things in life, there are different philosophical approaches to managing money.Personally, I am a value investor. I believe that every asset has what is known as an intrinsicvalue, that is a true value that is equal to all of the cash it will generate for the owner fromnow until doomsday discounted back to the present at an appropriate rate that takes into account

    the risk-free Treasury return, inflation, and an equity risk premium. Over time, I look forbusinesses that I believe are trading at a substantial discount to my estimate of intrinsic value.This causes me to buy very few businesses each year and, over time, has led to very good results.This doesnt always mean owning bad companies with low price-to-earnings ratios because,theoretically, a company could be cheaper at 30 times earnings than another enterprise at 8 timesearnings if you could accurately value the cash flows. In the industry, there are mutual funds thatspecialize in this type of value investing Tweedy, Browne & Company, Third Avenue ValueFunds, Fairholme Funds, Oakmark Funds, Muhlenkamp Funds, and more.Other people believe in what is known as growth investing which means simply buying thebest, fastest growing companies almost regardless of price. Still others believe in owning onlyblue chip companies with healthy dividend yields. It is important for you to find a mutual fund or

    family of mutual funds that shares the same investment philosophy you do.

    5) Look for Ample Diversification of AssetsWarren Buffett, known for concentrating his assets into a few key opportunities, has said that forthose who know nothing about the markets, extreme diversification makes sense. Its vitallyimportant that if you lack the ability to make judgment calls on a companys intrinsic value, youspread your assets out among different companies, sectors, and industries. Simply owning fourdifferent mutual funds specializing in the financial sector (shares of banks, insurance companies,

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    etc.) is not diversification. Were something to hit those funds on the scale of the real estatecollapse of the early 1990s, your portfolio would be hit hard.

    What is considered good diversification? Here are some rough guidelines:

    y Dont own funds that make heavy sector or industry bets. If you choose to despite thiswarning, make sure that you dont have a huge portion of your funds invested in them. If its abond fund, you typically want to avoid bets on the direction of interest rates as this is rankspeculation.

    y Dont keep all of your funds within the same fund family. Witness the mutual fund scandal ofa few years ago where portfolio management at many firms allowed big traders to market timethe funds, essentially stealing money from smaller investors. By spreading your assets out atdifferent companies, you can mitigate the risk of internal turmoil, ethics breaches, and otherlocalized problems.

    y Dont just think stocks there are also real estate funds, international funds, fixed incomefunds, arbitrage funds, convertible funds, and much, much more. Although it is probably wise

    to have the core of your portfolio in domestic equities over long periods of time, there areother areas that can offer attractive risk-adjusted returns.

    6) The Case for IndexFunds

    In the article If You Can't Beat 'Em, Join 'Em - The Case for Investing in Index Funds, I pointed

    out that, "According to the folks at the Motley Fool, only ten of the ten thousand actively

    managed mutual funds available managed to beat the S&P 500 consistently over the course of

    the past ten years. History tells us that very few, if any, of these funds will manage the same feat

    in the decade to come. The lesson is simple; unless you are convinced you are capable of

    selecting the 0.001% of mutual funds that are going to beat the broad market, you would best be

    served by investing in the market itself. How? By beginning a dollar cost averaging plan into

    low-cost index funds, you can be absolutely certain you will out perform a majority of managed

    mutual funds on a long-term basis."

    For the average investor who has a decade or longer to invest and wants to regularly put asidemoney to compound to their benefit, index funds can be a great choice. They combine almostunfathomably low turnover rates with rock bottom expense ratios and widespread diversification;in other words, you really can have your cake and eat it, too.

    Interested? Check out Vanguard and Fidelity as they are the undisputed leaders in low-cost indexfunds. Typically, look for an S&P 500 fund or other major index such as the Wilshire 5000 or theDow Jones Industrial Average.

    7)A Word on International FundsWhen you invest outside of the U.S., the costs are higher as a result of currency conversions,trust procedures for foreign investments, analysts capable of understanding foreign accounting

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    rules, and a host of other things. Although high, it is not unusual for an international equity fundto have an expense ratio of 2%. Why do some investors bother owning international funds? Inthe past, stocks of foreign countries have shown low-correlation with those in the United States.When constructing portfolios designed to build wealth over time, the theory is that these sharesarent as likely to be hit hard when the American equities are crashing and visa versa.

    First, if you are going to venture into the international equity market by owning a fund, youshould probably only own those that invest in established markets such as Japan, Great Britain,Germany, Brazil, and other stable countries. The alternatives are emerging markets which posefar greater political and economic risk. The economic basis for digging a gold mine in the Congomight be stable, but there is nothing stopping an armed military group from kicking you out theday your work is finished, reaping all of the rewards for themselves.

    Second, virtually all international funds chose to remain unhedged. This means that you areexposed to fluctuations in the currency market. Your stocks, in other words, could go up 20% butif the dollar falls 30% against the yen, you may experience a 10% loss (the opposite is also true.)

    Trying to play the currency market is pure speculation as you cannot accurately predict with anyreasonable certainty the future of the British pound. Thats why I personally prefer the TweedyBrowne Global Value fund which hedges its exposure, protecting investors against currencyfluctuations. Even better, its expense ratio is a very reasonable 1.38%.

    8) Know the Appropriate Benchmark for Your Mutual FundsEach fund has a different approach and goal. Thats why its important to know what you shouldcompare it against to know if your portfolio manager is doing a good job. For example, if youown a balanced fund that keeps 50% of its assets in stocks and 50% in bonds, you should bethrilled with a return of 10% even if the broader market did 14%. Why? Adjusted for the risk youtook with your capital, your returns were stellar!

    Some popular benchmarks include the Dow Jones Industrial Average, the S&P 500, the Wilshire5000, the Russell 2000, the MSCI-EAFE, the Solomon Brothers World Bond Index, the NasdaqComposite, and the S&P 400 Midcap. One quick and easy way to see which benchmarks yourfunds should be measured against is to head over to Morningstar.com and sign up for a premiumsubscription which is only around $14.95 per month. You can then research reports on variousfunds and find out how they evaluate them, view historical data, and even get their analyststhoughts on the quality and talent of the portfolio management team. Talk to your accountant itmay even be tax deductible as an investment research expense!

    9)Always Dollar Cost AverageYou know, youd think wed get tired of saying it but dollar cost averaging really is the single

    best way to lower your risk over long periods of time and help lower your overall cost basis foryour investments. In fact, you can find out all the information on dollar cost averaging what it

    is, how you can implement your own program, and how it can help you lower your investment

    risk over time in the article Dollar Cost Averaging: A Technique that Drastically Reduces

    Market Risk. Take a moment and check it out right now; your portfolio could be much better

    served because you invested a few minutes of your time.

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    In Conclusion

    There are a ton of great resources out there about choosing and selecting a mutual fund

    including About.coms very own Mutual Fund site which goes into much greater depth on all of

    these topics and more. Morningstar is also an excellent resource (I personally have a copy of

    their Funds 500 book on my desk as I write this article.) Just remember that the key is to remain

    disciplined, rational, and avoid being moved by short term price movements in the market. Your

    goal is to build wealth over the long-term. You simply cant do that moving in and out of funds,

    incurring frictional expenses and triggering tax events.

    Good luck! We here at Investing for Beginners wish you many happy returns!