How to Select a Mutual Fund

Once you have set up a brokerage account with a company you like, it’s time to start investing. You can start really small. (I started with putting $200 every so often in various funds.) Putting small amounts in the market is better than waiting and putting a large amount later. The sooner you put money in, the sooner interest will start compounding – which is much better for you in the long run.

If you haven’t set up an investment account and don’t know where to start with any of this, please see my first post here.

Anyway, let’s talk about mutual funds. This is the type of investment I recommend for passive investors and people that are just starting out. It can really get you some decent returns over time and requires minimal effort or monitoring. But how do you choose one?

This post will be based around the assumption that you opened a Fidelity brokerage account, but it can still apply to you no matter where you have an investment account. Keep in mind that these are my opinions and things that have worked for me specifically. (I’m not responsible for how your investment or the market goes.) Let’s get into it!

First, go to the mutual funds section of Fidelity’s site (which is under News & Research). Here you have endless options at your disposal. 

Here is what I look for at first glance:

  • No transaction fee. You don’t want a fund that charges a load or commission – it is a waste of money, when there are so many great options without one.
  • Higher Morningstar rating. Morningstar ratings reflect how well the fund has performed over time. The higher the amount of stars, the better the performance compared to risk. 2020 has completely messed with a lot of fund ratings, so this isn’t an end-it-all factor. But as a general rule, I try to select funds with a 4-5 star rating. After the crash of 2020, I have started selecting funds that are 3 star rated as well. I never select funds below 3 stars.
  • An expense ratio <1%. Expense ratios determine how much is charged for the management of the fund. This is not a brokerage expense. This covers the work the fund managers do to keep the fund diverse and thriving. A lot of amazing funds have low expense ratios, so there is no need to buy one that’s higher than 1%.

Once I’ve filtered and narrowed the list down with these criteria, I delve deeper into each fund’s details. Click a fund that looks good and pull up the performance and holding details. I will break this section out between longer term investments and short term investments. You can choose which of these selection processes to use, based on your investment strategy.

Longer Term Investments:

With these types of investments, you are looking for more steady returns over time. Your risk will be a bit lower, but it could be awhile (years) before you see a sizeable return on your investment.

  • Look at the average annual return. What are the percentages for 1 year, 3 years, and 10 years? Are these in the double digits? With a good fund these days, returns should be in the double digits. 
    • Focus on the long term returns (5-10 years). A fund in the 20%+ might be a good one.
  • Look at the holdings. Do you recognize the companies? Do you believe in the long-term success of these companies? Is the sector of the fund (technology, health, consumer finance, etc) something that you think could keep growing for years to come? This is important when buying a fund you plan on keeping for a number of years.
  • Look at the performance graphs for 3Y, 5Y, and 10Y. I really love looking at the 5 year graph first.
    • Has the fund been gradually going down over time (use the 5 & 10 year graph for this)? You might want to look at other funds if the over time trend of the fund is declining.
  • Look at the risk level. For longer term, you probably want a medium-low to medium amount of risk.
  • Minimum required to invest. Some funds have minimums when buying, so keep that in mind when trying to buy. The system will not let you purchase if you are under the investment minimum.
  • If all else fails, with longer term investments, its a safe bet to throw your money into an index fund, based on the top large-cap companies within the market (like Apple, Microsoft, Amazon, Johnson&Johnson, etc). This will almost guarantee gradual growth overtime.

Shorter Term Investments:

With these types of investments, you are looking for quicker and larger returns in a shorter period of time. Your risk will be higher, but you could make a lot more than with a slower growth long term investment.

  • Look at the average annual return. What are the percentages for 1 year, 3 years, and 5 years? Are these in the double digits? With a good fund these days, returns should be in the double digits. 
    • Focus on the 1-3 year returns. A fund in the 20%+ might be a good one, but you won’t know until we look at the graphs (explained below).
  • Look at the holdings. Are these companies in a position for more rapid growth in the near future? A simple google search of some of the major companies within the fund could help you estimate if the companies are poised for more immediate success.
  • Look at the performance graphs for 1Y, 3Y, and 5Y. I really love looking at the 3 year graph first.
    • Is the fund at an a high point for this time period? If it is, it could indicate that slower, more steady growth is ahead – or even that the fund could start declining. This might not be the best thing to buy for a short term investment if you want to maximize your returns.
    • Is the fund in a trough or a low? If so, this could be a great opportunity for you. You really want to buy lower, so you can sell it for higher. But before buying you should research the following:
      • Why is the fund at a low? Is the sector suffering for a specific reason?
      • Based on that reason, do you think it will recover soon or go even lower before recovering? It could be a good idea to wait a few weeks to get the lowest price.
      • What do analysts say about the fund’s major holdings? I love using MarketBeat.com for this. I simply type in the ticker symbol for one of the companies (example: APPL for Apple) and go to “analyst ratings” to help me determine what experts are thinking will happen with the company in the next 6 months. These analysts provide a buy, sell, or hold rating. If most analysts think you should buy or hold the major companies within the fund, this mutual fund could be a great option for you to buy.
    • Has the fund been gradually going down over time (look at the 3 and 5 year graph for this)? You might want to look at other funds if the overtime trend of the fund is declining.
  • Look at the risk level. For shorter term, it’s normal to look for a medium to a higher amount of risk.
  • Minimum required to invest. Some funds have minimums when buying, so keep that in mind when trying to buy. The system will not let you purchase if you are under the investment minimum.

I hope this helped you with your fund selection process. It can seem overwhelming at first, but when you break it down, it doesn’t have to be as complicated. Follow these steps, and I think you will be well on your way to starting a successful investment journey. 

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