The How-to's of Mutual Fund Research

Today, I’ll follow up with some suggestions about how to do mutual fund research for your 401k, 403b, or IRA. You can apply the analysis to funds in your retirement plan, as well as to funds that you’ve uncovered in other ways. Also, I want to stress the importance of asset allocation in your 401k, especially during these volatile times in the market. A GREAT tool for doing this can be found on eRollover.com's site by using our asset allocation tool. 

Screening requirements for your mutual Fund research

When beginning your mutual fund research, I suggest looking for no-load funds rated five stars by Morningstar, with Morningstar “low” or “below average” risk ratings, and with three- and five-year historical returns at least as good as the S&P 500 index. I also advise stipulating that the same manager has to be running the fund for at least five years. 

Finally, I suggest specifying that passing funds should have minimum initial purchase requirements consistent with your specific needs in your 401k, 403b, or 457 Plan. I’ll assume that the funds you are researching meet those requirements, with the possible exception of the five-year historical return and five-year manager tenure. Entering in five-year returns and manager tenure is encouraged, as it tends to disqualify newer funds.

When I do my mutual fund research, I try to gravitate towards funds with at least a 5 year track record, however it is your call whether you want to allow funds with only a three-year history of returns. Morningstar’s website has the best collective set of tools I am aware of with the comprehensive data needed to do the most thorough mutual fund research. However, eRollover.com does have a mutual fund screener that can suit your needs by clicking our mutual fund research tool. 

Start by entering your fund’s name or ticker symbol on Morningstar’s homepage www.morningstar.com  to see the snapshot report for the fund. If for example, you are looking for a no load fund, In the Key Stats section, confirm that the fund is no load by looking for the word “none” under both “Front-load %” and “Deferred Load %”. You will also probably want to make note of the required minimum initial investment, which is also listed in under the key stats. Make sure that you use the Morningstar rating report to confirm that the fund’s Morningstar rating is either “low” or “below average,” as well as the management report to confirm the manager’s tenure. 

Check returns of your mutual funds

For all funds, whether from my screen or not, switch to the Total Returns report to see the fund’s calendar year and past return figures. Calendar year returns are returns for specific years such as 2004 or 2005. By contrast, the return figures in the past are the average annual returns for periods ranging from one to 10 years, if the fund has been around that long. These figures are computed through the previous market day, and thus, are more current than the calendar year returns. Morningstar also compares each mutual fund’s performance to the S&P 500 index for each period. That figure will be positive if the fund did better than the S&P during the period and negative if it lagged behind the index. 

The most important figures are the fund’s trailing 3- and 5-year returns vs. the S&P 500. Look for funds that outperformed the S&P by at least 5%, ideally over both the three- and five-year periods. If you decide to waive the five-year check, require at least 8% outperformance vs. the S&P 500 over the past three years. Also check the fund’s one-year returns vs. the S&P index. Since, one-year is a relatively short timeframe for evaluating fund performance, require only that the fund match the S&P’s return. Ignore year-to-date and the shorter timeframe’s listed by Morningstar. Finally, in the return section, note the 2002 calendar year returns. That was the year the S&P 500 dropped 22 percent, making it the worst year in recent memory. By noting a fund’s 2002 calendar year’s results, you can see how it performs during a bad year. 

Another risk check when doing mutual fund research

Our final risk measure is price/earnings ratio. You may be familiar with the price/earnings ratio of a stock, which is its recent share price divided by one-year’s per share earnings. A mutual fund’s price/earnings ratio is the based on the average P/E of its individual stocks. Research has found that low P/E mutual funds are less risky and produce better returns over time than high P/E funds. Using Morningstar’s numbers, investors who are very conservative should avoid funds with P/Es above 15. I think that is a great way use Morningstar in your mutual fund research to navigate your way through the universe of 20,000+ Mutual Funds. Always keep in mind, getting consistent returns over a prolonged period in your 401k isn't about timing the market. It is accomplished by coming up with a solid plan and investing for the long term.