Navigating the World of Mutual Funds

Since the 1920s, mutual funds have helped Americans achieve their financial goals. Today they are one of the most popular investments. According to the Mutual Fund Education Alliance, more than 80 million investors in the United States own mutual funds.

But if you’re like most investors, you may have questions about different fund types, class shares, expenses and how to select the funds most suitable to your investment needs. You’ll find answers to these questions in this five-part series of articles about the world of mutual funds.

What is a mutual fund?

Mutual funds are often referred to as open-end funds. This means there is no limit to the number of shares investors can buy and sell. You might also hear about closed-end funds, which are investment companies that sell a fixed number of shares traded only on the stock market.

The money you invest in a mutual fund is pooled along with that of other shareholders with similar financial goals. Most mutual funds are part of a larger investment company or family of funds. Each fund is managed by a team of professional money managers who monitor the fund’s performance and, based on thorough research, choose investments they believe will help the fund reach the investment objectives stated in the prospectus (for example, current income or capital growth).

Because a mutual fund is essentially a collection of different investments, investors use them to reduce investment risk without having to purchase individual stocks and/or bonds. Diversification, while recommended, does not guarantee a profit or ensure against a market loss.

Another advantage of investing in mutual funds is liquidity. Generally, you can redeem or sell your shares any day the stock market is open. However, you should keep in mind that investment values will fluctuate and there is no assurance that the objective of any fund will be achieved. Mutual fund shares are redeemable at the current net asset value, which could be more or less than their original cost. Fund annual operating expenses apply as well as plan administration charges. These are described in the prospectus.

Stock mutual funds

If you’re considering investing in a mutual fund, you’ll need to know about the types of funds that are available. You can select a stock or equity fund, bond fund, balanced fund (a combination of stock and bond funds), lifestyle fund or money market fund. In Part Two of this series, we’ll take a look at stock funds.

Generally, stock or equity mutual funds are best suited for investors who:

o Seek capital growth over extended periods of time
o Are willing to tolerate share-price volatility
o Have an investment horizon of five or more years

Stock funds can have different investment objectives and target companies in various industry sectors and market capitalization (the gauge of a company’s size or value). Funds invest in companies within one of the three market capitalization categories: large-cap funds (more than $11.7 billion), mid-cap funds ($2.9 billion to $11.7 billion) and small-cap funds (up to $2.9 billion).

The following are the different types of stock funds, ranked in order of the highest to lowest investment risk:

Aggressive growth funds-Seek rapid growth of capital, often through investment in smaller companies and with investment techniques involving high-risk, short-selling, leveraging and frequent trading.

Growth funds-Seek capital appreciation by investing in equity securities of companies with earnings that are expected to grow at an above-average rate. Current income, if considered at all, is a secondary objective.

Growth and income funds-Seek capital appreciation and current income equally by investing in equity securities that have above-average yields and some potential for appreciation.

Income funds-Seek income rather than capital appreciation by investing primarily in equity securities of companies offering good dividends.

International stock funds-Invest at least two-thirds of their portfolios in equity securities of companies located outside the U.S. (global stocks). Domestic (U.S.) stocks may or may not be held.

Specialty funds-Seek capital appreciation by investing at least 65% of assets in equities of a single industry or sector, such as financial services, healthcare, natural resources, precious metals, real estate or utilities.

Lifestyle Funds-Invest in other funds and are optimized to reflect levels of risk and return suitable to specific times of an investor’s life.

Bond funds

As the name suggests, bond funds are mutual funds investing in various types of bonds. Bond funds may be appropriate for investors who:

o Value relatively steady income over growth
o Seek yields that are potentially higher than money market rates
o Want to diversify investments
o Can accept modest fluctuations in the share price

Bond funds aren’t the same as bonds. There’s no fixed yield nor contractual obligation to repay investors their principal at a future date, as is the case with bonds. Bond fund managers continually trade their positions, so the risk-return characteristics of a bond fund investment is always changing, just as with other mutual fund investments.

The main types of bond funds include:

Corporate bond funds-Seek a high level of income by investing two-thirds or more of their portfolios in corporate bonds.

Global bond funds-Invest in worldwide debt securities. Up to 25% of their portfolio’s securities (not including cash) may be invested in companies located in the United States.

Government bond funds-Invest at least two-thirds of their portfolios in U.S. government securities and have no stated average maturity. Bonds issued by Uncle Sam are backed by the full faith and credit of the U.S. government.

High-yield bond funds-Seek a high level of current income by investing at least two-thirds of their portfolios in lower-rated corporate bonds (Baa or lower by Moody’s and BBB or lower by Standard and Poor’s rating services).

Mortgage-backed funds-Invest at least two-thirds of their portfolios in pooled mortgage-backed securities.

National municipal bond funds-Invest predominantly in municipal bonds. The funds’ bonds are usually exempt from federal income tax but may be taxed under state and local laws.

Other world bond funds-Invest at least two-thirds of their portfolios in a combination of foreign government and corporate debt. Some funds in this category invest primarily in debt securities of emerging markets.

State municipal bond funds-Invest primarily in municipal bonds of a single state. The funds’ bonds are exempt from federal and state income taxes for residents of that state.

Strategic income funds-Invest in a combination of domestic fixed-income securities to provide high current income.

Other mutual fund investments

In addition to the stock and bond funds described in previous articles, mutual fund investing offers other choices that might be appropriate to your circumstances and goals. These choices include:

Balanced funds

These funds, also known as hybrid funds, are a combination of stock and bond funds. Balanced funds seek high total return by investing in a mix of equities, fixed-income securities and money market instruments. Unlike flexible portfolio funds, these funds are required to strictly maintain a precise weighting in asset classes.

Money market funds

Money market funds typically invest in short-term government and company loans, which, while lower-yielding, are generally less risky than many other types of funds. Money market funds can be appropriate for investors who:

o Need access to their money in the near future
o Are looking for a current short-term rate of interest
o Are very conservative in their investment approach

An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Therefore, while the fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money while investing in the fund.

Classification of class shares

When you invest in a mutual fund, you purchase a share of that fund. There are different share classes in which you can invest, the most common of which are class A, B and C shares. Share classes vary mainly in the type of sales charge and expenses you incur. The best share class for you depends on a number of factors, including the amount you plan to invest and how long you plan to hold the shares.

Share types

o Class A shares have a front-end sales charge you pay at the time of purchase and is deducted from your investment amount.

o Class B shares typically do not have an up-front sales charge. Instead, a class B share has a contingent deferred sales charge (CDSC) that declines each year until it eventually expires. Once their CDSC expires, Class B shares convert to Class A shares.

o Class C shares do not have an initial sales charge. Rather, they also have a contingent deferred sales charge-typically 1% if shares are sold within the first year. They do not convert to Class A shares and have an ongoing, higher management fee.

Operating expenses

All mutual funds have operating expenses that may include management fees, distribution fees or 12b-1 fees and shareholder mailings, among other expenses. You do not pay for these directly. Instead, they are deducted from the fund’s net assets-or the overall return of the fund. For more information on a fund’s fees and expenses, refer to the fund prospectus.

A fund’s total expense ratio is the combination of the different operating expenses, such as advisory fees, distribution fees and ongoing fees. The fund’s expense ratio is a means to compare its cost to that of other funds and to learn about the fund’s fees and expenses.

Shareholder fees include any commissions paid to brokers when shares are bought or sold. These commissions are often described as “front-end loads” (sales charges when you buy) or “back-end loads” (sales charges when you sell). No-load funds, as the name implies, do not have front-end or back-end sales charges, but generally do have operating expenses and shareholder fees.


Each year, mutual funds outside of an employer tax-qualified plan must distribute substantially all of their income and capital gains to shareholders. As a result, shareholders of a mutual fund generally must pay income taxes on dividends and capital gains, if any. Each fund provides an IRS Form 1099 to shareholders annually to summarize the fund’s dividends and capital distributions. Then, when a shareholder sells shares of a fund, the shareholder will realize either a taxable gain or a loss.

Determine your financial objectives

Choosing the type of investment that is right for you depends on your financial goals. Are you saving for college or your retirement? Do you need stable income or can you afford a longer-term investment with greater historical risk, but potentially higher returns? Before investing in a fund, carefully review the fund’s investment style, performance history and expense ratio, and consider your time horizon and level of risk tolerance.

The Pros and (Mostly) Cons of Mutual Funds

Why purchase a mutual fund?

The chief reason investors purchase mutual funds are for diversification. A fund may hold as little as twenty securities all the way to several hundred. These can include stock, bonds as well as cash. If your investable assets are under $50,000, mutual funds can be an ideal tool to diversify your portfolio. By investing, you are in fact paying for a professional manager or team of managers to oversee your investment. Since mutual fund companies have huge amount of money to invest, they may have the advantage of meeting directly with the CEO and upper management of a company before investing. This is certainly an advantage they have over an individual investor. If you are busy living your life or don’t have the investment skills to research individual stocks, purchasing a mutual fund may be the ideal investment.

Need to sell quickly, no problem!

Most investors think of a mutual fund as a long term investment. However, selling a mutual is as easy as selling a stock. If you place an order to buy or sell a mutual fund, you will receive pricing at the close of the day; not at the exact time you call to place the order.

The pitfalls of mutual funds

As with every security, mutual funds do have their drawbacks. While a manager is bound to invest according to the mutual fund’s prospectus, you do not have control over what individual stocks your manager buys or sells. If you have an objection to a certain stock such your manager purchasing a tobacco stock, you have no recourse except of course to fire the manager and redeem your shares.

Hot one year, cold the next

With a mutual fund, your money is pooled with other investors. This can create a tremendous problem for you as well as the fund manager. Money may pour into a hot mutual fund you own. This may force the fund manager to hold that money in cash or invest in other stocks outside the fund’s intended purpose. This is generally the reason a top performing fund may suffer in its return the following year. Remember, your mutual fund company is all about their bottom line too. The more money they have in assets under management, they more fees they will bring into their firm.

In addition to inflows, there are redemptions your fund manager must take into account. Should there be a mass exodus of the fund you’ve invested in, your fund manager must sell shares to pay the shareholders who have sold the fund. In many cases, a mutual fund may hold cash to account for redemptions. This may cause problems for you as well as it may put a drag on your total return.

Taxes, taxes, taxes

One huge problem and perhaps the biggest drawback to investing in a mutual fund are the tax liabilities you will have at the end of the year. If you mutual fund manager sold stocks due to shareholder redemption or simply sold stocks because they feel that a particular stock within the mutual fund’s portfolio has reached its full potential return, your fund experiences a capital gain. This capital gain is passed onto you and you must claim it as such on your tax return; even if you haven’t sold any shares. These gains must be distributed to all share holders by the end of the year. Typically your fund will report these gains in November or December. If you are contemplating investing in a mutual fund later on in the year, you must call and ask when their distribution date will occur so you don’t get stuck with a tax bill. Here’s a double whammy: if your fund had capital gains on some stocks but still suffered a loss in NAV (net asset value), you still may be liable to pay the tax for the capital gains generated early in the year.

Note: This only applies to taxable accounts. If you are a mutual fund investor and it is held in a non taxable account such as a 401k or IRA, the above does not apply as you are not taxed until you withdraw your money out of your retirement funds.

Most fund manager do not beat their benchmark

If you are getting a little concerned,there’s more sobering news. Most fund managers do not beat their unmanaged benchmarks. Researchers at Standard and Poor’s did a study in 2006 and found that only 38% of large cap fund managers managed to beat the S&P 500 (the standard benchmark which a large cap fund manager would be judged against) over a 3 year period. Over a 5 year period that number drops to 33%. It gets much worse for small cap investors. Small cap fund managers lagged their benchmark by 24% over a 3 year period and just 21% beat the corresponding index over a 5 year term. That means that over a 5 year period, you have a 67 to 79% chance of losing to an unmanaged index. In addition to the reason listed above, there is the human factor. Throughout the history of the market, investors have been seeking the holy grail of investing. If the highest paid smartest mutual fund managers haven’t found it after 100 years, chances are it doesn’t exist.

Fees and commissions

As an investor, you are in effect paying fees to a company to professionally invest your money for you. I can’t think of a single fund company that sends you out an itemized bill at the end of the year. However by law, mutual fund companies must send out a prospectus detailing every fee they charge. If you have insomnia, they are highly recommended reading. Before investing, please call the fund company and consult with your financial planner. Get educated about your investment before sending them any of your hard earned money. Remember, mutual funds collect their expense fees from you regardless of how successfully they were.

Here’s a highlight of mutual fund fees and expenses:

1) Class A share fund fee-These are typically known as “loaded funds” and will charge a percentage of 1-6%. Over time, this can take a huge chuck out of your total return

2) Class B share fund fee-These are typically know as “back end loaded funds” and will charge a percentage when you sell your shares. Most back end loaded fund charges will dissipate if kept for a number of years. For example, if you keep a back end loaded fund for 5 years, the mutual fund company may waive their fee

3) Investment management fees-This money goes to cover the advertising and salary expenses required to run the fund.

Knowing your fund’s expense ratio is paramount if you are going to have a successful investing career. The average expense ratio for a mutual fund is around 1.5%. This means out of every $10,000 you invest, $150 is being deducted for expenses no matter how your mutual fund performed.

Think expenses aren’t important? Consider this fact: $100,000 invested over 25 years will turn into $684,500 if you achieve an 8% return. If you squeeze out just another 2% more over a 25 year period, you will have nearly $1,100,000; a difference of $415,500. This could be the difference between sipping mojitos on the beach and having to take a job as a greeter at Walmart in your “golden years”. Invest wisely and consult with a financial advisor. Your future may depend on it.

Paradigms of Mutual Funds


In today’s scenario, one of the upcoming options for investment in the financial market is mutual fund. Mutual funds special features are it: easy availability, risk containment, liquidity, transparency, professional management and decent returns, these above features attract the small investors mainly of average class, the investors play safer game as compare to the up and down of the stock market.

Many private financial organizations like ING VYSA Bank, Standard Chartered Mutual Fund etc are good examples, which allow investors to start with just Rs 500only. Investors seem to have accepted the importance of mutual funds and are know a days ready to invest under various mutual fund schemes.

Suitability of Funds

Mutual Fund suits all class of investors who are interested in raising their personal funds. The investments are based on the risk factor of the investor if the risk is higher the return is also high similarly if the risk is low the return on a particular investment will also be low.
If the risk is slightly-averse, the investor should prefer a balanced fund, which invests in stocks only up to 60-70%. If the investor wants to go for larger risk-averse, stick to growth funds. If the investor wants regular returns than investor must go for income funds, with average risk but the risk is less than equity fund. The Mutual fund managers make decision of the funds depending on the investment objective of the investors. They can go for liquid funds like Cash Funds or short term floating rate funds. They may also go for funds based on when you want your funds back. The investor who wants short term and quick return a short-term bond fund would just be fine as return will be within three to six months. An income fund or an equity fund would fit in if the investor willing to afford the fund to leave it with the fund manager for over a year.

Even within each category, you can pick and choose i.e. in equity funds, for example, you have a variety of options: blue chip funds, mid-cap funds, contrarian funds, opportunity funds, dividend yield funds, sectoral funds that invest specifically in select business segments etc. Equity-linked savings schemes allow you to reap tax gains up to Rs 1 lakh (Rs 100,000) a year.

Many equity funds offer the option of systematic investment plan (SIP) that allows you to invest a certain sum every month or every quarter. This amount is fixed for every installment to be paid. This way, you not only discipline your investments but to a great extent an investor can protect themselves against the vagaries of the market.

Debt funds don’t lack luster either. The investor have a choice medium term debt funds, short-term bond funds, floating rate funds, dynamic bond funds and cash funds. If an investor wants an aggressive debt fund, then they can go for gilt funds. If the preference is a mix of both equity and debt, MIPs or balanced funds would do just fine.

Fair and Transparent dealings

A mutual fund is nothing more than a collective savings pool. Several investors have come together to invest in stocks, bonds or in both. However, mutual funds are strictly regulated. They have to declare their portfolios from time to time. Almost all the funds declare their portfolios every month.

The net asset value (NAVs) of a fund, which points to how much a unit of the fund is worth on a particular day, is declared every working day. You know where your money is going and how it is doing performing in the market.

Easy Access and Availability in Market:

A few years ago, even if you wanted to buy a mutual fund, it was not easy. Few distributors, most of them small, sold mutual funds. The quality of their advice often left a lot to be desired. But today, you could buy mutual funds in over 60 cities or towns, either through their own offices or through banks.
All private sector banks now sell mutual funds across the counters in most branches. Some public sector banks too have begun marketing mutual funds through select branches.

Professionally Managed

When you buy a mutual fund, you hand over the task of investing to a qualified and probably more knowledgeable fund manager who is paid for finding the right opportunities for you. The service standards set by mutual fund companies are better as compare to other sources of raising finance. As other sources of raising funds are more risky than mutual funds as their investor have to do the direct dealings. As for example, most fund distributors will come to your residence or office and explain the product features and also collect your cheque.

If you want to sell your fund, you can do so pretty quickly too, mostly within one or two working days. There is no paperwork to fear. For example, in the case of some income funds, the money will be credited directly into your bank account if the account is held with select banks.

In case of systematic investment plans too, you can do so with auto debits. Every month, on a day you choose, your bank account will be debited with a particular sum and specified mutual fund units available for that sum will be bought. No more hassles of issuing post-dated cheques .

Despite all these facilities, you may have myriad doubts and queries. Mutual funds offer toll-free lines at over 200 locations. For example, call-free telephone line, you can get to know valuations, order for account statements and even redeem your investments without any personal identification number.

How to Evaluate and Choose Mutual Funds

Many investors today utilize mutual funds as part of their overall investment plan. Whether you must make your own mutual fund selections for your 401(K) or employer sponsored retirement plan, or use a professional investment advisor for other types of investment accounts, mutual funds can be an effective way to own baskets of stocks or bonds, with a small amount of investment dollars.

Understanding Mutual Funds

To successfully invest in mutual funds, you should understand what they are and how they work, so let’s start with some basics.

A mutual fund is a company that gathers money from many investors, and allocates that money by buying stocks, bonds or other assets. A mutual fund is like a big basket which holds a number of investments like stocks or bonds. When you buy a mutual fund, you actually buy a piece of the basket. In this way, you can own a small percentage of many different assets that you might not otherwise be able to afford on an individual basis.

The value of the fund is based on the value of the assets it holds. As the stocks or bonds within the fund increase in value, the fund increases in value. Conversely, as the stocks or bonds within the fund decrease in value, the fund also decreases in value. Mutual funds only trade at the end of the day based on their net asset value (NAV). To determine the NAV at the end of the trading day, the mutual fund company looks at all of the assets that are in the basket, determines their value and divides that number by the total number of outstanding shares in the fund.

Types of Mutual Funds

Mutual funds are divided into two categories: closed-end funds and open-end funds.

Closed-end funds have a fixed number of shares issued to the public. If you want to purchase a piece of the fund, you have to purchase an existing share from a shareholder that is selling.

Open-end funds have an unlimited number of shares. If you want to purchase a piece of the fund, the fund creates a new share and sells it to you. There are significantly more open-end funds than there are closed-end funds. Closed end funds can trade at values that are above or below their NAV, while open end funds only trade at their end of day NAV.

Mutual Fund Research – Do Your Homework


All mutual funds have expenses. Some funds’ expenses are low while other funds’ have very high expenses. These include everything from the advisory fee paid the fund manager to administrative costs like printing and postage.

With a little bit of homework, you can determine a fund’s expenses before you invest. This is important because those expenses can have a dramatic effect on your investment returns. The three expenses you should be aware of are loads, redemption fees and operating expenses.

Loads are commissions or fees that can be charged either when you buy or sell a mutual fund. A front-end load (usually associated with class “A” shares) can be up to 8.5% of your investment. A back-end load (usually called redemption fees, are associated with class “B” shares) can also be quite high, but reduces over the years, the longer you keep your investment in the fund. Class “C” shares do not have a front or back end load, but have extremely high operating expenses deducted each and every year. These loads are usually used to pay a commission to the agent who sold you the fund. No-load funds, on the other hand, do not charge any commission at the front or back end.

Operating expenses are generally stated as an annual percentage called the operating expense ratio. These fees cover the operating and trading costs for the fund, as well as management fees that go to pay the fund manager for his expertise and time.

12(b)-1 are fees that cover advertising and distribution expenses for the fund. These fees are charged in addition to a front- or back-end load.

When doing your homework, look for no load funds that do not charge 12(b)-1 fees, and have a low operating expense ratio. Studies have shown that load funds with high expense ratios perform no better than comparable no-load funds.


Another point to consider when investing in mutual funds is taxes. When a fund manager sells a stock or bond within the basket for a gain, IRS regulations provide that this gain be taxed to the shareholders of the fund. This means that a fund with a high “turnover” (a fund that buys and sells a lot within the basket each year) could have a great deal of gains that will be taxable to the shareholders. The tax gains are passed through to the shareholders who own the fund as of a specific date each year. This means that someone buying the fund just before the taxable distribution date, will pay the tax on the gain for the entire year, even though they did not own the fund all year. For more tax efficient funds, look for funds that have a low turnover rate.


By law, a mutual fund company must outline all of the above expense information, and a great deal more, in their prospectus. A fund’s prospectus will specify a fund’s objectives and its past performance, information about the fund manager and the fees associated with the fund.

Past Performance

A common mistake for novice investors is to select a mutual based solely on its past performance record. Past performance may not be a food indicator of future performance, given possible changes in the global or domestic economy, the markets, or specific sectors the fund invests in. While past performance is a useful tool and one item to consider, it should not be the sole criteria. In many cases last year’s winners are next year’s underperformers.


A fund that has been in existence five to ten years or more has a much better track record to assess than a relatively new fund that have not necessarily had performance measured during various economic or market periods. The longer the period of history you have to review, the higher the quality of historical performance data.

Portfolio Holdings

When investing in mutual funds (or any investments), it is important to be diversified (see my blog titled “The Truth About Diversification”). Sometimes, owning a few different mutual funds may give the appearance of being well diversified, but on closer inspection, if the funds you own, each have major holdings in the same stocks, you may not be diversified at all. One test is to check the fund’s ten largest holdings. In the more concentrated funds, the ten largest holdings may comprise a significant percentage of the portfolio; in the less concentrated funds, they may hold a much lower percentage. Always know what specific investments your fund or funds own to remain diversified.

Portfolio Manager

Mutual funds are managed by a portfolio manager, or in some cases, by a team of portfolio managers. The success of a fund by an individual fund manager may be largely dictated by his performance. That is important to know, because a fund with a good track record historically, may perform differently in the future if the fund manager changes. It is always prudent to review the tenure of the fund manager in concert with past performance.


There are several key statistical numbers that provide valuable information about a mutual fund. Fortunately, we do not have to calculate those statistical numbers ourselves as they are readily available.

Alpha – measures the performance of a fund on a risk-adjusted basis. Alpha calculates a risk factor relative to a fund, and then compares that risk-adjusted performance to a benchmark (such as the S&P 500). A number is then assigned that reflects how that fund performs, relative to the amount of risk the investment is exposed to. For example, a positive alpha of 1.0 means the fund has outperformed its benchmark index by 1%, or a negative alpha of -1.0 would indicate an underperformance compared to the benchmark of 1%.

Beta – measures how a mutual fund performs in relation to the market as a whole. A beta of 1 for example, means that a mutual fund will move up or down in value in tandem with the market. A beta of 2.0 would mean a mutual fund would go up twice as much as the market when it the market increases, but it will also go down twice as much when the market decreases. That means this would be a much more volatile fund. A conservative investor would look for investments with a lower beta, rather than a higher one.

Standard Deviation – measures the risk, or volatility of a mutual fund or investment. For example, a mutual fund might have a ten year average annual return of 8%. At first blush, that might look very good. But let’s say that this fund had a standard deviation of 20. This would tell us that although the fund had on average returned 8% over ten years, it did not earn 8% each and every year. Some years may have been up and some may have been down, but the average was 8% overall. The standard deviation number tells us that we should expect that this fund “could” return 20% more or 20% less than 8% in any given year, most, but not all of the time. There are certain times, more rare but possible, that a fund might move two or three standard deviations above or below the average 8% (60% more or 60% less). In a down market, that could be painful. The lower the standard deviation, the less risk or volatility a fund has.

In conclusion, doing a little homework on mutual funds can really pay off later on not only in terms of performance, but also in terms of understanding risk and diversification. You will find that all of the information discussed above is easily available on a number of internet sites, including Yahoo, MSN, and Morningstar to name a few.

What Kind of Mutual Funds Should I Buy?

What exactly defines the “best mutual funds” anyway? Funds are by far the most widely used investment vehicle in the world. There are now more mutual funds than there are stocks in the US market. With over 26 thousand funds that Morningstar keeps track of, how can someone know where to find the best ones?

You’ve come to the right place to find out!

You’ll have to read all the way to the end of this page to see my recommended list of “Best Mutual Funds for 2009”. But before we dive into that, let’s back up and do a little mutual fund 101.

What is a mutual fund? A mutual fund is the most popular form of a pooled investment known today. They are designed for people who want to have their money professionally managed at a fairly reasonable cost. In addition to professional management, they give an investor convenience, diversification, record keeping, tax reporting, and safekeeping of securities.

How do mutual funds make money? Mutual funds make money in several ways. The main way is from internal fees that are called expense ratios. Expense ratio sounds a lot better than FEES, right? But it’s the same thing. It’s a percentage of the funds assets that are taken out every day, and it’s how the mutual fund company stays in business. You never see these fees come out, but they definitely affect your annual returns. You want to try to make sure your expense ratios are around 1% or less per year. Some specialty funds are going to be higher, but for the most part you should try to buy funds that are under 1%. Funds are required by law to produce a document called a prospectus, which no one ever reads, that tells you important information about the fund. Fortunately, Morningstar reports most of this same information in a much easier to understand way. The best mutual funds will keep these internal costs to a minimum.

What about commissions? This is an important one. Many mutual funds sold today by bank brokers and full-cost brokers like Merrill Lynch and Edward Jones have commissions, or loads. Loaded funds commissions can vary, but most are between 1% and 5.75%. That means for every $1000 you invest, $45 to $57.50 could be coming out for a commission to the broker, and the rest gets invested into your account. That’s not such a bad thing if the broker getting paid is actually helping you manage your account of mutual funds. Loaded funds can have either front-end or back-end commissions. Front-end means you pay it when you go into the fund with new money, these are called A share funds. Back-end means you pay it when you eventually sell the shares, these are called B share funds. With a B share, the back-end commission gradually declines the longer you hold it. It’s usually completely gone after 7 years. The problem is, B share funds have much higher internal expense ratios, sometimes 2.5% per year. This is how they make up for the commission that they paid the broker when you bought it. If you’re going to buy a loaded fund, you should NOT buy a B share. The other option is a C share. C share funds have no commission when you buy it, and a 1% back-end commission if you sell within the first year. The best mutual funds will have little or no commission on them.

What are 12b-1 Fees? These are another kind of internal fee that you’ll never see come out, but you need to be aware of. Most loaded funds have 12b-1 fees, and a few no-load funds do too. These are basically an annual trailing commission that goes to the broker who sold you the fund. It’s supposed to be his or her incentive to continue to take care of your account. It’s generally .25% per year, so it’s not going to break you. But when you add that on to an up front commission of 5.75%, and an expense ratio of 1.50% or 2.5%, and it starts to become very difficult to keep up with the market. If you’re looking for the best mutual funds, try to avoid 12b-1 fees.

What are No-Load funds? No load funds are funds that have no commission for the investor to pay at all. So every $1 that you invest goes right into the fund. Some famous no-load mutual fund companies are Fidelity Investments, Vanguard, and the Dimensional Funds. The only way a no-load mutual fund makes money is from the internal expense ratios. But that doesn’t mean that their expense ratios are higher. In fact, quite the opposite can be true. No-load funds are in our opinion are some of the best mutual funds available today.

What is an ACTIVELY managed fund This is a fund where the fund manager is actively buying and selling securities inside the fund in attempt to outperform the market. Many people think that actively managed funds are the best mutual funds. Keep in mind that each time a trade is placed, the fund has to pay a commission. These commissions are in addition to the funds expense ratio and are only reported in the annual report. Morningstar says that these trading commissions can run as high as 1% – 2% of the funds assets per year if the manager is a very active trader. You can get a feel for how much trading is going on by looking at the funds turnover rate, which is also reported by Morningstar. If a fund has a turnover ratio of 50%, that means the manager is selling and then buying again 50% of the funds assets each year. Many stock funds commonly have turnover ratios of over 100% per year.

Also, when a stock inside a fund is sold by the manager, any capital gains that are realized from that sale will be passed on to you as the shareholder. So even though you didn’t do anything, you could be paying taxes on your investment at the end of the year. Funds will estimate the amount of capital gains that they plan to pay out at the end of each year. It’s important to look at those estimates (usually published in November) and see if you should sell your shares before they pay it to you. This way you can avoid taking that gain and getting taxed on it. Yet, some of the best mutual funds are still actively managed.

So what’s a PASSIVELY managed fund? A Passively managed fund, usually called an index fund, is a portfolio of stocks or bonds that replicate a major market index. The S&P 500 or the Lehman Brothers Aggregate Bond Index are two major indexes that most people have heard of. There are a lot of people who now agree that the best mutual funds are passively managed. Passively managed funds are very low cost funds to own because there are not a lot of analysts doing research on what stocks to buy and sell. These kinds of funds generally don’t do much trading of the stock or bonds they own, so this keeps the trading commissions and taxes low. Expense ratios of passively managed funds are usually in the 0.08% – 0.5% range, much lower than actively managed funds. These are an excellent choice for an investor who is satisfied to match the performance of the index.

So which mutual funds ARE the best mutual funds? OK, so you’re just about ready to see my list. The best mutual funds to own tend to be index type funds. The truth is, most actively managed mutual funds UNDER-perform the major market indexes over time. There are a lot of reasons for this, and we’ve already mentioned most of them. Commissions, expense ratios, and taxes all add to the cost of owned actively managed funds. All these costs make it much harder for the manager to keep up with, not to mention out-perform the market index. Here are a few quotes from some famous investors about investing in index funds…

“…the best way to own common stocks is through index funds… – Warren Buffett, Berkshire Hathaway Inc. 1996 Shareholder Letter

“A very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money,” – Warren Buffett 2007

“Additionally, those index funds that are very low-cost (such as Vanguard’s) are investor-friendly by definition and are the best selection for most of those who wish to own equities.” – see page 10 of Berkshire Hathaway Inc. 2003 Annual Report

“Over the 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job. Instead many investors have had experiences ranging from mediocre to disastrous.” – page 5, 2004 Berkshire Hathaway Annual Report

“Most individual investors would be better off in an index mutual fund.” – Peter Lynch

Finally, I’m done with all of that! Now here’s my list of recommended funds for your own portfolio for 2009.

The Best Mutual Funds For 2009

The following are all no-load funds. (Of course!)

Dimensional Small Cap Value (DFSVX) This is a small cap value fund that I believe is poised to perform extremely well as the market and economy begin to recover from this recession. Small cap stocks tend to be the first to recover after a recenssion ends, and this fund should be a top performer. Dimensional funds are index funds, but they are enhanced index funds. Dimensional Fund Advisors takes a market index and then screens out the stocks they feel are less likely to perform as well. They use 26 different screening methods to narrow down the list of stocks they want to buy. Then they use some timing and trading strategies to determine when to buy the stock.

Dimensional Emerging Markets Value (DFEVX) This is an index fund that invests in emerging foreign countries. Emerging markets, or under-developed countries, also tend to lead in performance coming out of a recession. This fund invests in countries like Brazil, Chile, China, South Africa, Czech Republic, Hungary, Mexico, Poland, Israel, Malaysia, South Korea, Indonesia, Philippines, Thailand & Turkey. It does not invest currently in Argentina.

Dimensional Tax Managed US Marketwide (DTMMX) This is another index fund that invests in large, mid and small cap companies here in the United States. Morningstar has is rated as a mid cap, but it really invests in all of them. Due to it’s heavy mid and small cap holdings, I believe it is also poised to do well coming out of this recession.

iShares FTSE/Xinhua China 25 Index (FXI) This is actually an ETF (which is basically a mutual fund). Basically this is an index fund that buys the 25 largest and most liquid Chinese companies. The Chinese market lost a huge amount of it’s value in 2008 and has some great potential for 2009. This fund trades on the NY stock exchange, and trades just like a stock. This fund lost almost 68% of it’s value during the last 12 months, so there can be some heavy volatility here. Don’t bet the farm on it, but this would be a nice portion of your international exposure. Save yourself the effort of doing research on Chinese companies and just buy some of this.

iShares U.S. Financial Sector (IYF) This is another ETF index fund that tracks the Dow Jones U.S. Financials Index. This fund lost over 75% of it’s value during the last 12 months, and is now having a nice rebound as you can imagine. I think there is most likely some great potential for returns in the financial sector, and a low cost index fund like this is an excellent way to get some exposure.

Energy Select Sector SPDR (XLE) Yes, it’s another ETF index fund that invests in companies from oil, gas, energy equipment & energy services. This is a great, low-cost way to get exposure to the entire energy sector, including the servicing companies. These stocks all tend to move up and down with the price of oil. Last year oil got over $147/barrel in May, and by October it was below $38/barrell. We could easily see oil prices right back up above $100 in no time at all.

Dimensional International Value (DFIVX)

This is another DFA index fund that invests in developed foreign countries. This would include the following: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom. This would be an excellent choice for the bulk of your international exposure.

Amana Mutual Income (AMANX) This is a large cap value fund that invests in mostly U.S. stocks for preservation of capital and current income. It currently has a 5-star rating from Morningstar. Although this is not a small cap fund, you still need to have some exposure to large caps at all times in your portfolio. The unusual thing about this fund is that investment decisions are made in accordance with Islamic principals. It diversifies investments across industries and companies, and generally follows a value investment style.

Fidelity Strategic Income (FSICX) This is another one of my best mutual funds picks for 2009. This is a bond fund that invest in many different types of bonds, so it’s called a multi-sector bond fund. It invests primarily in debt securities by allocating assets among four general investment categories: high yield securities, U.S. Government and investment-grade securities, emerging market securities, and foreign developed market securities. The fund uses a neutral mix of approximately 40% high yield, 30% U.S. Government and investment-grade, 15% emerging markets, and 15% foreign developed markets. High yield bonds are another type of investment that tend to out-perform as the economy and market begins to recover.