Analysis of mutual funds

How to analyze mutual funds?

Before investing in mutual funds a proper analysis of what and where you will be putting your hard earned money is required.

Don’t make the beginner’s mistake of looking at past returns and letting that convince you into investing in a mutual fund.

While all the efforts at analyzing a mutual fund is aimed towards helping you maximize your returns and ensuring that the mutual fund you are investing in is closely correlated to your investing goals, it is equally about minimizing risks.

The aspect of minimizing risks is what stands out as the single most fundamental criterion to compare mutual funds.

This article makes you aware of:

  • How can you do a mutual fund analysis?
  • Important is the risk factor analysis?
  • Why is it important to track the record of mutual fund companies?

Investing in mutual funds is not child’s play unless one does a mutual funds’ analysis. At least it is not as easy as picking top performers going by indices and investing in them.

Here are some basics that you should know before you invest in mutual funds.

Fundamental Objectives of Investment

To begin with our mutual funds’ analysis you need to be clear about the investment objectives you have, that is whether the objective is growth of capital or regular income.

Whatsoever be the case, the basics of objective of investment are not to be forgotten.

Mutual funds analysis
Mutual funds analysis

It is needless to say that you need to have some rudimentary knowledge of investing in stocks and securities apart from street smartness to research mutual funds.

Here are a few tips for analysis before investing mutual funds.

We will begin our exercise from the point you have collected all the relevant information about competing funds.

1. Look at the Portfolio of Your Pick of Funds

Most of the plans will have invested in multiple stocks or securities for diversification. Critical point here is in what proportion they have invested in different stocks.

Mutual funds can be formed for various investment needs. You have the aggressive high growth mutual funds, and there are fixed income mutual funds and the low growth but relatively stable funds.

This is achieved by allocating the funds across a different segment of stocks.

When analyzing the mutual fund, look at how much weightage is given to the stocks and also if it is volatile.

A higher weightage to a particular asset will mean lesser allocation to other assets and could potentially interfere with your investment needs.

2. The Optimum Portfolio Size

Investors should also look at the optimum portfolio size when looking at mutual funds.

The portfolio size is nothing but the collection and size of the assorted investments in a mutual fund or a plan.

Although you might hear things differently, it always pays to understand what sectors your mutual funds are exposed to, to get an idea of the allocation.

Pay particular attention to the exposure to certain sectors of the stock market. This could potentially mean you are either capitalizing or losing out on growth prospects.

Roughly speaking around 65% to 85% may be allocated in stocks from different sectors for diversification plus growth and the balance allocated towards typical bonds and money market instruments.

3. Is Your Pick of Funds Really Diversified

Notice that the competing plans, though from different fund companies, perform almost on par as if they have a correlation. They indeed have.

So, does it mean you have diversified by spreading your money amongst them? Well, think again. Similar plans have similar pattern of their holdings of stocks and with a similar portfolio.

This means, in actual effect you are not diversifying. They all go up and down almost as if they do it in tandem. For clear diversification, pick those with different portfolios though they are similar plans (ex: growth, index or dividend paying etc).

What are the risks factors with Mutual funds?

Warren Buffett on risk
Warren Buffett on risk

Legendary investor Warren Buffett says risk results from putting money in stocks that are not among the best. It is not important how big a portfolio your plan has, instead how many of them are the best of the stocks.

For example, a prospectus may tell you they invest in 50 stocks for a particular plan. But you can easily say not more than half of them are fundamentally good.

1. Don’t Ignore Expenses

Every mutual fund charges some kind of fees/loads to cover expenses.

Then there are taxes to pay in most of the cases. Typical average expense charged by fund managers is 1.5% though there are funds that charge you as low as 0.2% also.

Even 1.5% might appear a small figure but it could make a big difference to you over a long invested period even if you had invested as little as $ 10,000.

2. Track the Track Record of Companies

To check mutual funds, the shortest time frame you should check for is three year period.

As mutual funds are long term investments, it is better to stick to a fund (plus its manager) that has shown consistent performance over long periods (a ten years time is the benchmark).

A hot performance of a quarter or a year may suck investors who chase them but even for a short term investment, it is advisable that long term track records are important.

3. Who Is Managing Your Fund

Finally taking a look at the fund’s manager should tell you why the fund is performing as it had. If a fund has a new manager at the helm of affairs after a strong five year performance, it is something to be cautious. Not that you should refrain from that company.

Digging deeper into his historical abilities at managing funds throws light on his track record as a fund manager (to find a manager’s history click on the Profile tab on the Yahoo! Finance Mutual Fund Quote Page).

There are times when you come out winners even with blind investing. But it pays to do a thorough research even in a bull market before investing.