How to Choose Mutual Funds

June 15, 2007


In the last podcast I explained the “WHEN, WHERE, and HOW” of investing, but based upon a few of the emails that I received I need to review a few basic concepts of investing.

First let’s play the definition game (definitions provided by www.about.com ):

Stocks – Instruments that signify an ownership or equity in a company. These are purchased as shares whose value can increase or decrease as the value of the company’s assets increase or decrease.

Bonds – A written promise to repay the principal amount upon maturity and to make specified interest payments to the bond holder.  A bond is a debt of obligation and the interest and principal, when due, are payable to the holder.

Mutual Funds – An investment tool that allows investors to participate in a diversified portfolio with other investors.  A company collects the funds of several investors and then uses the funds in a variety of investments.  Each investor shares in the gains and/or losses.

No-Load Funds – A mutual fund that does not charge any commissions.

Index Funds – A mutual fund whose portfolio of stocks is weighted the same as the stock exchange index. An index fund is set up to mirror the performance of the stock index.

In the last podcast I gave you my opinion that for those that have less than $200,000 should consider using Fidelity’s Freedom Funds or Vanguard’s Target Retirement Funds. Both of these fund companies (Fidelity and Vanguard) are mutual fund companies. I had several people that wrote to me that were confused as to what type of investments these asset allocation funds were. If you go look them up and research them through www.Morningstar.com or some other research site you will find that they are funds that are made up of other funds. This provides you with a great deal of diversification with one simple investment.

Now let’s get back on track and discuss “HOW TO CHOOSE MUTUAL FUNDS”…..

First you guys need to know my thoughts on what is known as Efficient Market Theory

Efficient Market – Since everyone has the same information about a stock, the price of a stock should reflect the knowledge and expectations of all investors. The bottom line is that an investor should not be able to beat the market since there is no way for him/her to know something about a stock that isn’t already reflected in the stock’s price.

I feel that this Theory holds true for Large Cap. US Companies.  There are really only 1,000 Large Cap Companies (Cap Value > $10 Billion).  Meanwhile there are pundits, analyst, and advisors like myself on every street corner to evaluate these 1,000 stocks.  With the vast amounts of information and the speed that information now reaches us through the Internet, Cable Business Channels, AM Business Talk Radio how could you know anymore than anyone else?

Plus the average mutual fund charges 1.5% of internal expenses versus a good index fund that only charges .10%. The resulting 1.4% difference in fees is the amount that an active manager has to outperform the broad large cap index.  There is a reason that on a running 10 year history the S&P 500 outperforms approximately 70% of the actively managed large cap mutual funds.

So with all of this explanation I believe that most investors should use Index Funds and ETFs to cover their Large Cap US Investments (The S&P 500).  The only exception is if you have access to great funds like Dodge & Cox Stock (DODGX) and other great funds that consistently beat the Index.  Unfortunately, most great funds like this are closed to new investors.

Inefficient Markets – Foreign (International Stocks) and Small Cap Stocks are what I consider to be inefficient markets.  You would be much better served if you used really good managers that consistently beat their benchmarks.

Let’s Recap and Review:
1) Buy Index Funds for your US Large Cap Exposure
2) Buy good managed Funds for International and Small Company Exposure

A good tool to help you determine which funds to invest with is the “Mutual Fund Screener” available through Yahoo Finance (click here) This tool will allow you to sort and filter through the ever growing mutual fund universe.  A few key areas that you may want to consider when using the tool:

** Category
** Rank in Category
** Manager Tenure
** Morningstar Rating
** 3 & 5 Year Return Annualized (The 5 year will be really helpful to see how the fund handled the Bearish 2002)
** Min. Initial Investment
** Front Load (this is where you will want to adjust the filter to only allow “No-Load” Mutual Funds
** Expense Ratio

All of this data can be a tremendous help in determining which funds will fit nicely into your diversified portfolio.


Only $29/year provides you with a quarterly guide to make the best financial decisions and keep you up to date with the changing investment world.  All proceeds directly help offset the cost of the podcast.

This quarter’s “Wealth Report” covers the following topics:
**How Mismanaged 401(k)s Put Many Retirees in Jeopardy
** An Analysis of Variable Annuities (Buyer Beware)
** Important planning changes in how to handle Retirement Beneficiaries
** Five Economic Indicators to Watch Now
** A Checklist of Estate Planning Essentials

You can subscribe by either:
* Paypal email account: [email protected]
* Donate at the site (indicate on the donation form that the payment is for the “Wealth Report” Newsletter at www.Money-Guy.com
* Mail a check made payable to “Preston Financial, Inc.” to:
Brian Preston
Money-Guy.com Podcast
1611 S Zack Hinton Pkwy
McDonough, GA 30253




Most Recent Episodes

Financial Advisors React to Money Advice from ChatGPT

Will ChatGPT be your new financial advisor? In this react episode, we’ll break down some money advice from ChatGPT and compare it to our own thoughts and opinions. Enjoy the Show? Sign up for the Financial Order of Operation (FOO) Online Course! Sign up for our Know...

Financial Planning 101 (By Age) 2023 Edition

Throughout every decade, there are different areas of your financial life that come in and out of focus. In this episode, we'll discuss what you need to focus on by age, pitfalls to watch out for, and how to know you're doing it right. In this episode, you'll learn:...

Is the 2023 Housing Crash Around the Corner?

Housing prices skyrocketed after the pandemic to all-time highs, and mortgage rates have more than doubled since 2020. Homes are harder to purchase for more Americans, which means it’s more important than ever to make sure you are ready to buy before purchasing. In...

Watch This Before Rebalancing Your Investment Portfolio!

85% of Americans don’t rebalance their 401(k). Are they making a huge mistake? In this episode, we’ll discuss the “why” behind rebalancing, how to do it, and the data on whether or not rebalancing can increase your return. In this episode, you’ll learn: What...

Don’t Make This HUGE 401(k) Mistake!

Americans are making a HUGE mistake in their 401(k) that could cost them thousands by retirement. We’ll talk about why this is happening and how you can avoid making the same mistake in this Q&A episode! For more information on how to make the most out of every...

Alex Hormozi’s Top Money Advice! (Financial Advisors React)

In this episode, we react to Alex Hormozi's financial advice. Enjoy the Show? Sign up for the Financial Order of Operation (FOO) Online Course! Sign up for our Know Your Number Course! Check out our Net Worth Tool! Get FREE downloads full of financial advice from...

Everything You Need to Know About Finances in Your 20s

In this episode, we discuss everything you need to know about finances in your twenties. In this episode, you’ll learn: The top financial advice for your twenties How to start building wealth and the steps you should take Enjoy the Show? Sign up for the Financial...

The Most Valuable Asset in Building Wealth!

This episode will show you how to maximize the most valuable resource you have - starting right at this moment. What is it, you may ask? It’s TIME. If you give your money time to grow, you’ll be amazed at how much your dollars can become - it’s incredible! How wild is...