Comparing Mutual Funds

by Catherine Rein
(last updated April 17, 2009)

In October of 2007 there were 8,015 mutual funds listed with the Investment Company Institute (ICI), a national trade association of investment companies in the United States. Mutual funds have several advantages over investing in individual stocks. You can get easy diversification with a mutual fund and you have the expertise of a professional fund manager.

Finding the right mutual fund for your needs means knowing a little bit about the ways mutual funds are measured. You can analyze a mutual fund by looking at its classification, its performance and its expenses.

  • Classification. Mutual funds are classified in two major categories, closed-end and open-end. Closed-end funds have a limited number of shares; you have to purchase an existing share to buy into the fund. Open-end funds have an unlimited number of shares. From there, mutual funds are broken into one of 48 different categories based on the assets held by the fund. Some examples of the categories include Large Value, Small Growth, Specialty Natural Resources and International Hybrid.
  • Performance. One way to compare the performance of mutual funds is through their Morningstar ratings. Morningstar rates funds using a "star" system – with five stars being the highest rating and one star being the lowest rating. Five stars indicate it ranks in the top 10% of its Morningstar category. Mutual funds are also compared based on their performance over time, Year to date, 1 year, 3 Years, 5 years, etc.
  • Expenses. Every mutual fund has expenses. You need to research these expenses and factor them into the funds overall performance. Loads are fees that mutual funds charge either when you buy (front-end load) or when you sell (back-end load). There are also funds that don't charge a sales fee (no load). Redemption fees are charged if you sell your mutual fund before a certain date. Operating fees are charged to cover the cost of the fund manager for his expertise and time and to cover the cost of advertising and distribution.

The lowest expenses are typically associated with so-called index funds. These are funds that have their asset allocation tied to a certain index. Index funds typically have an expense ratio of less than 0.2% per year. This means that on a $100,000 investment you would pay $200 in annual expenses. Higher expenses are associated with actively managed funds. The average expense ratio for these funds is 1.5% per year.

Author Bio

Catherine Rein


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