Good and Bad Mutual Funds

Good and Bad Mutual Funds

Most mutual funds offered by reputable fund companies or families have good intentions. It's in their best interest to perform well and beat their benchmarks. Others make a token effort to perform, and are more concerned with making big profits for the fund company. Here's how the business works, and how to separate the good from the bad.

Professional money managers make the investment decisions in actively managed mutual funds. Only in index funds is performance a given, because they are passively managed to simply track an index. The vast majority of traditional mutual funds are actively managed.

Simply put, it is fund management's job to outperform the market in general, and to beat the competition. If a manger excels at his job, everyone benefits. The manager gets a raise for outstanding performance. The fund company benefits as investors pour more money into the fund because it has proven itself to be a winner. Investors benefit directly as their money grows.

That's how a good mutual fund operates. All funds make their money from the yearly expenses they charge investors. The more money they have under management, the more profit they make for the mutual fund company.

For example, if a fund grows from $1 billion in assets under management to $2 billion and charges investors 1% a year, it basically doubles its income. Much of this goes to the bottom line, since expenses do not increase proportionately.

Now, here's a thought for you. In the past 30 or so years, mutual fund assets under management have grown like crazy. Yet, many stock funds are charging investors 2% and more for yearly expenses while others charge less than 1%.

Why would a large mutual fund company need to charge investors 2% or more? What's the objective here, and whose side are they on?

There is one sure way I know of to separate the good guys from those who are looking out for themselves. Every mutual fund has an EXPENSE RATIO, and it tells the investor how much it costs a year to be invested in the fund. Plus, information is available that compares a fund's expense ratio to other similar funds.

Do not believe for one minute that you get what you pay for. High expenses come out of investors' pockets, and act to directly lower investment returns. No mutual fund can guarantee good performance, but it would be nice to know that your fund is on your side and doing the best it can for you as an investor.

If you want to separate the good guys from the bad guys, look no further than the expense ratio.

A retired financial planner, James Leitz has an MBA (finance) and 35 years of investing experience. For 20 years he advised individual investors, working directly with them helping them to reach their financial goals.

Jim is the author of a complete investor guide, Invest Informed, designed for average investors or would-be investors of all levels of financial background and experience. To learn more about investments and investing and his new financial guide go to http://www.investinformed.com

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