Why Top Mutual Funds is About You, Not the Funds

top mutual funds

By: Robert F. Abbott, freelance writer and author of Big Macs & Our Pensions

Everyone wants to own the top mutual funds, so you would think only a small number of funds might take care of us all. Yet, we know thousands of mutual funds exist, and all of them attracted at least some buyers. At some time in the past, every one of those thousands of investment dogs (and stars) appeared on someone’s list of top mutual funds.

This fact underlines the point that top mutual fund can mean a lot of different things. After all, even though we may own dogs, we thought they were the best mutual funds when we bought them, or at least we expected them to become leaders.

Quite simply, your top performing mutual funds will differ from my top funds because of different needs and different perceptions. Your best mutual funds will be as unique as you. In this article, we review a few of the paths to uniqueness.

You’re reading the first in a series of articles that will help you make sense of those lists of top mutual funds, or best mutual funds. Other articles include:

Where are You in the Life Cycle?

If you’re relatively young, your investing needs will differ considerably from a person who is relatively old. You will have decades to make up for any losses, so you can afford to take more risks. This means you can search among stock, or equity, funds for your top mutual funds.

On the other hand, if you’re ready to retire, you will want to take fewer chances. This makes bond funds a more likely destination when you search for your best funds.

Keep in mind we’re talking about relative, rather than absolute views. A younger person might invest 80% in equities funds and 20% in bond funds, while the person nearing retirement would hold 80% of her portfolio in bond funds and 20% in equity funds.

A common rule of thumb suggests making the safer portion of your portfolio equal to your age. So, if you’re 32 years old, you would put 32% in of your investments into something safe like government bonds, and 68% in more aggressive vehicles, such as stock funds. Just the opposite will hold if you’re 68.

Risk Tolerance and Top Mutual Funds

Imagine two people born in the same year, but having very different tolerances for investment risk. They will put together distinct lists of best mutual funds.

Assume they’re both 25 years old, and both want to invest in stock funds. The one with higher risk tolerance will likely create a best funds list that includes a heavier weighting toward riskier—and often more rewarding—vehicles. That might include funds that embrace small cap stocks, emerging markets, or oil and gas stocks.

The one with the lower risk tolerance will develop a distinct top funds list. It might include large cap stocks (big companies, less risk than small companies), domestic stocks (no worries about currency risks from holding international stocks), and dividend-paying stocks (generally stable companies).

What will You Find If You Search for Top Mutual Funds

If you consider yourself a do-it-yourself mutual fund investor, you will can go online and search for one of these phrases:

  • top mutual funds
  • top performing mutual funds
  • best mutual funds, or
  • best performing mutual funds
    (You might also use the singular, fund, rather than the plural, funds)

The search results will often show lists of funds with prices that increased more than others in the past day, week, month, year, five years, or ten years.

You’ll find lists from companies such as Morningstar, Zacks, and a host of others. Morningstar not only has lists, but also a screener that helps you create a list of top mutual funds based on your own criteria. However, you may find that too ambitious at this point; instead, start with a look at the lists available from U.S. News & World Report (this is not a recommendation, just one place where you might begin).

U.S. News & World Report divided its top funds list into 12 categories, providing something for just about everyone who plans to invest in mutual funds. These rankings average the scores from five big players in the mutual fund industry, including Morningstar and Zacks. Again, these funds are considered best because of their price growth in a specific time period (1 year in this case).

Now it’s time to go back to your self-analysis (life cycle, risk tolerance, and other factors) and identify the types of funds you want working for you.

Not sure what you’ll find in the categories? Click on the category name–Best Fit Mid-Cap Value, for example—and read the description that comes up. Need still more information? Then do a search from your browser; after hitting a few websites you should understand the types of securities within each type of fund, and for whom they will work best.

Basic Assessment Criteria for Lists of Top Funds

You haven’t reached the end of the line with a list of top mutual funds; rather, you’ve got a shorter list, and now you can do more research on each of the funds within that category.

Long-term Performance: Check the longer-term record for these funds. The five-year performance will show you how the fund has fared through roughly four years of a bull market and one year of a bear market. Look at the ten-year performance to see how the fund has done since 2006 (at the time of writing), a period which includes the financial crisis of 2008, followed by a bull market and bear market.

If the fund has less than a five-year record, think of it as a newcomer and not suitable for a cautious investor.
Size of fund: Bigger funds usually offer more security and stability, but do not capture quick gains like smaller funds. Smaller funds can move more quickly to exploit emerging opportunities.

Management expense ratio (MER): This shows the cost—to you—of owning these funds, top-rated or not. Generally, the lower the better, since you might call the MER the money you’re leaving on the table. If possible, find funds with MERs of less than 1%, and watch for any fund charging more than 2.5% (rough guidelines).

Reputation of the fund company: Overall, the industry has a good record, but before making any buying decision, do an online search for the name of the company or institution selling the fund(s). If you feel any doubts, move on. Almost every category of fund is available from multiple fund companies.

Conclusion

When you go out searching for the top mutual funds or the best mutual funds, always remember it’s more about you than about the mutual funds.

The top performing mutual funds or best performing mutual funds may have led the pack over the past 12 months. But did they do well over the past five years and ten years?

The real top funds list for you will reflect your age, your risk tolerance, and more. In particular, it will reflect your confidence in how this fund will perform in the future, as distinct from the past.

In turn, your personal expectations for the future will color your confidence in different types of funds. We cannot know the future, but with knowledge of ourselves and of our investment priorities, we can profit from buying top mutual funds.

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The Writer

Robert F. Abbotttop mutual funds is a freelance writer; see his profiles and analyses of value stocks at GuruFocus.com . He is also the author of Big Macs & Our Pensions: Who Gets McDonald’s Profits?

In this book, you will:

  • Discover the Ownership Revolution, and what it means to your retirement funding.
  • Find out how much of your lunch bill is a profit for McDonald’s, and who gets the profits.
  • Learn how corporate profits fuel one of the greatest social programs ever developed.

Click here to read a free preview at Amazon.com