Managed Mutual Fund and ETF Portfolios

Our clients must first identify his or her goals and desires for the money being invested. Are long-term capital gains desired, or is a current income preferred? Will the money be used to pay for college expenses, or to supplement a retirement that is decades away? Identifying a goal is important because it will enable you to dramatically whittle down the list of the more than 27,000 mutual funds in the public domain.

In addition, our clients must also consider the issue of risk tolerance. Is the investor able to afford and mentally accept dramatic swings in portfolio value? Or, is a more conservative investment warranted? Identifying risk tolerance is as important as identifying a goal. 

Finally, the issue of time horizon must be addressed. Investors must think about how long they can afford to tie up their money, or if they anticipate any liquidity concerns in the near future. Ideally, mutual fund holders should have an investment horizon with at least five years or more.

If the investor intends to use the money in a fund for a longer-term need and is willing to assume a fair amount of risk and volatility, then the style or objective they may be suited for is a long-term capital appreciation fund. These types of funds typically hold a high percentage of their assets in common stocks and are, therefore, considered to be volatile in nature. They also carry the potential for a large reward over time.

Conversely, if the investor is in need of current income, he or she should acquire shares in an income fund. Government and corporate debt are two of the more common holdings in an income fund.

Of course, there are times when an investor has a longer-term need, but is unwilling or unable to assume substantial risk. In this case, a balanced fund, which invests in both stocks and bonds, may be the best alternative. Our firms research department has identified 6 portfolios from Capital Preservation to Aggressive with the proper mix of asset classes and appropriate mix of stocks, bonds and cash based on one’s risk tolerance and time horizon.

Mutual funds make their money by charging fees to the investor. A front-end load fee is paid out of the initial investment made by the investor, while a back-end load fee is charged when an investor sells his or her investment, usually prior to a set time period, such as seven years from purchase.Both front- and back-end loaded funds typically charge 1 to 6% of the total amount invested or distributed, but this number can be as much as 8.5% by law. Its purpose is to discourage turnover and to cover any administrative charges associated with the investment. 

The investor should look for the management expense ratio. In fact, that one number can help clear up any and all confusion as it relates to sales charges. The ratio is simply the total percentage of fund assets that are being charged to cover fund expenses. The higher the ratio, the lower the investor's return will be at the end of the year.

We have found looking for consistent performing funds and monitoring them compared to their benchmark will more likely have better performance over time. Our portfolios will avoid both up front or back end sales charges by entering a flat advisory fee relationship for our research and monitoring which will avoid both up front and back end load fees.

Investors should research a fund's past results. The following is a list of questions of ways to evaluate managers and past results.

Did the fund manager deliver results that were consistent with general market returns?

Was fund performance over the past 1,3,5 and 10 years in the top quartile of performance relative to there peers?

Was the fund more volatile than the big indexes (meaning did its returns vary dramatically throughout the year)?

Was there an unusually high turnover (which can result in larger tax liabilities for the investor)?

There are times when a fund can get too big. A perfect example is Fidelity's Magellan Fund. Back in 1999 the fund topped $100 billion in assets and it was forced to change its investment process to accommodate the large daily (money) inflows. Instead of being nimble and buying small- and mid-cap stocks, it shifted its focus primarily towards larger capitalization growth stocks. As a result, its performance suffered.

Our mutual fund selection process may seem like a daunting task, but through use of technology and knowing your objectives and risk tolerance the process is quite simple. If our clients monitor their risk tolerance and we follow this bit of due diligence up front before selecting a fund, we will have a greater opportunity of success in our investment returns and outcomes.