Ranking Mutual Funds: Strategies For Smart Investment Choices

Mutual funds are a popular investment tool for those seeking to beat the market or access a wide range of investments. With over 9,000 mutual funds currently holding more than $16 trillion in assets, it is important to know how to rank them for investment. The best mutual fund portfolios are diversified, with funds focusing on U.S. stocks and bonds, as well as international securities, and offering both growth and value stocks. They also tilt towards low-fee funds. Ranking systems such as Zacks Mutual Fund Rank can help investors evaluate current funds, find better funds, and track their funds. Rankings reflect a variety of popular fund rating systems that track funds' historical and current performance, risk, and other metrics.

Low-fee funds

Benefits of Low-Fee Funds

When it comes to investing, keeping costs low is crucial. Fees eat directly into your investment returns, so minimizing expenses means more money stays in your pocket. Low-fee funds, also known as index funds, offer a cost-effective way to invest in the stock market. By passively replicating a chosen benchmark, index funds eliminate the additional costs of fund management and research teams. As a result, they often have lower expense ratios than actively managed funds, making them a more profitable choice for investors.

Examples of Low-Fee Funds

• Fidelity 500 Index Fund (FXAIX): With a net expense ratio of just 0.015%, this Fidelity fund is one of the lowest-cost investments in the mutual fund universe. It tracks the Standard & Poor's (S&P) 500 Index and has over $534 billion in assets under management as of Q1 2024.
• Fidelity ZERO Total Market Index Fund (FZROX): This Fidelity fund seeks to provide investment results that correspond to the total return of the entire U.S. equity market, including small-cap and mid-cap stocks. It charges no fees or loads and has a 0% expense ratio.
• Vanguard 500 Index Fund Admiral Shares (VFIAX): This Vanguard fund offers the opportunity to match the returns of the U.S. market with a minimal 0.04% expense ratio. It has delivered a 12.9% annualized pre-tax total return over the past 10 years.
• Vanguard Total Stock Market ETF (VTI): With an expense ratio of just 0.03%, this Vanguard ETF provides exposure to over 3,700 stocks covering nearly 100% of the investable U.S. stock market. It's a great choice for investors seeking broad diversification.
• Fidelity NASDAQ Composite Index Fund (FNCMX): While its 0.29% net expense ratio is higher than some other low-cost funds, it's still among the cheapest funds tracking the NASDAQ Composite Index. As of Q1 2024, it has over $15 billion in assets.
• Fidelity ZERO International Index Fund (FZILX): This Fidelity fund offers exposure to larger global companies to limit risk. It has a 0% expense ratio and no load, making it a truly zero-fee investment option.

Factors to Consider

When choosing a low-fee fund, it's important to consider factors beyond just the expense ratio. Here are some additional considerations:

• Performance: Evaluate the long-term performance of the fund, ideally looking at least five to ten years of data. While past performance doesn't guarantee future results, it can give you an idea of the fund's potential.
• Tax efficiency: Mutual funds tend to be less tax-efficient than ETFs due to taxable capital gains distributions at the end of the year. If tax efficiency is a priority, consider an ETF or a fund with a low portfolio turnover rate.
• Investment minimums: Some mutual funds have minimum investment requirements, while ETFs typically do not. If you're just starting with a small amount of money, an ETF or a fund with no minimum investment may be a better choice.
• Broker availability: Not all brokers offer all mutual funds, so check if the fund you're interested in is available through your broker. ETFs, on the other hand, are usually available at all brokers since they trade on an exchange.

Remember, when investing in mutual funds or any other financial product, it's essential to do your own research and consider your specific investment goals, risk tolerance, and financial situation.

Historical and current performance

Historical performance analysis:

• Annualised historical returns: When assessing mutual funds, it is common to look at the historical returns over different periods, such as 1-year, 3-year, 5-year, or even longer durations. This data is typically annualised, meaning it represents the average return achieved each year during that period. For example, if a fund has a 10% return in the "1Y" (1-year) column, it has generated a 10% return in the last year.
• Point-to-point return: In addition to annualised returns, it is worth considering the point-to-point return, which reflects the absolute return achieved over a specific period. This can provide insights into the fund's performance during different market conditions.
• Comparison with peers: It is crucial to compare the historical performance of a mutual fund with its peers and similar funds in the same category. This comparison helps identify how well the fund has performed relative to other options available to investors.
• Consistency of returns: While analysing historical returns, look for consistency in the fund's performance. Avoid making decisions based solely on a single year of outstanding returns, as it could be an outlier. Instead, opt for funds that consistently outperform their benchmarks and peers over multiple years.
• Market downturns: Choose funds that have demonstrated resilience during market downturns. This indicates the fund manager's ability to navigate challenging economic conditions and make strategic decisions to minimise losses.

Current performance and trends:

• Recent returns: Stay updated with the most recent returns data, typically available on a monthly, quarterly, or yearly basis. This information helps identify the fund's short-term performance and any emerging trends that may impact your investment decision.
• Performance against benchmarks: Compare the fund's current performance against relevant benchmarks and industry standards. This analysis provides context to the returns and helps assess if the fund is meeting or exceeding expectations.
• Ranking within category: Mutual funds are often ranked within their specific categories, such as large-cap, mid-cap, value funds, or sector-specific funds. Consider the fund's ranking relative to its peers to identify top-performing options.
• Impact of market conditions: Consider how the current market conditions and economic trends might influence the fund's performance. For example, a fund that performed well during a bull market may not necessarily deliver the same results during a bear market or vice versa.

Remember, historical performance does not guarantee future results, but it provides valuable insights into the fund's management, investment strategy, and ability to navigate different market environments. Always consider historical and current performance in conjunction with other factors, such as investment objectives, risk tolerance, fees, and the overall investment time horizon.

Risk and other metrics

Risk Assessment:

• Zacks Mutual Fund Rank: Zacks offers a ranking system that evaluates mutual funds based on their potential for future success, not just past performance. The ranking scale ranges from #1 (Strong Buy) to #5 (Strong Sell), helping investors make informed decisions.
• Volatility and Turnover: Understanding the volatility of a mutual fund is essential. Funds with higher volatility tend to have more significant short-term price fluctuations. Additionally, consider the turnover rate, which indicates how frequently the fund managers buy and sell securities. Higher turnover can create more taxable events, impacting long-term gains.
• Diversification: Diversification is a key strength of mutual funds. A well-diversified fund invests in a broad range of companies and industries, reducing risk. Examine the fund's portfolio to ensure it is not overly concentrated in specific sectors or individual stocks.

Other Important Metrics:

• Performance and Track Record: While past performance doesn't guarantee future results, it provides valuable insights into the fund's stability and historical returns. Analyze the fund's performance over different time frames to understand its consistency.
• Fees and Expenses: Mutual funds typically charge various fees, including expense ratios, sales loads, 12b-1 fees, redemption fees, and more. Minimizing fees is crucial as they directly impact your investment returns. Compare the fee structures of different funds to identify cost-effective options.
• Management and Strategy: Assess the fund's management team and their track record. Consider their investment strategy, such as active or passive management, and ensure it aligns with your investment goals and risk tolerance.
• Turnover Rate: The turnover rate indicates how frequently the fund buys and sells securities. A high turnover rate can generate more taxable events, affecting your overall returns, especially in a taxable brokerage account.
• Yield and Dividends: Depending on your investment goals, consider the yield or income distributions offered by the fund. Some funds focus on dividend-paying stocks or bonds, providing regular income.
• Ratings and Rankings: Utilize independent ratings and rankings from sources like Morningstar, Lipper, Zacks, TheStreet.com, and Standard & Poor's. These ratings provide a comprehensive evaluation of the fund's performance, risk, and overall strategy.

Remember, when ranking mutual funds for investment, it's essential to consider risk and other metrics in conjunction with your investment goals, risk tolerance, and time horizon. Conduct thorough research and due diligence before making any investment decisions.

ESG factors

When ranking mutual funds for investment, it is important to consider ESG (Environmental, Social, and Governance) factors. These factors help evaluate a company's sustainability and can be used to build a more ethical investment portfolio. Here are some key points to consider:

Environmental Factors

Environmental factors focus on a company's impact on the natural world and its efforts to conserve it. This includes assessing air and water pollution, green energy initiatives, carbon emissions, waste disposal systems, energy and water conservation, and the company's stance on climate change.

Social Factors

Social factors examine how a company treats its employees, suppliers, clients, and the wider community. This includes evaluating employee welfare, gender equality, pay parity, labour standards, employee relations, production quality and safety, local community impact, equal employment opportunities, and contributions to social causes.

Governance Factors

Governance factors relate to how a company is run and its leadership practices. This includes evaluating board independence and diversity, ethical business practices, executive compensation compared to employee pay, voting rights, shareholder rights, transparency in accounting and tax practices, and effective whistleblower policies.

Benefits of ESG Investing

ESG investing offers the potential for high returns, as studies have shown that companies with strong ESG practices may outperform traditional funds over time. Additionally, ESG funds have been found to have lower downside risks than traditional funds, particularly during turbulent market conditions.

Types of ESG Investments

There are several types of ESG investments, including individual stocks and funds. When considering ESG stocks, look for companies with high ESG scores and impact reports that highlight their sustainable and cultural initiatives. For funds, compare different options using a mutual fund screening tool and review prospectuses to understand the specific details of each fund.

Choosing ESG Investments

When choosing ESG investments, it is essential to identify your personal values and ensure they align with the ESG criteria. Research independent reviews and ratings from firms like Morningstar to evaluate how companies or funds score on ESG factors.

ESG Scoring

It is important to note that ESG scores are calculated by different companies using varying methodologies, so there is no single authority on ESG scores. However, most providers outline specific indicators and acquire data from company disclosures, government databases, and NGO databases.

Investment goals

Before investing in any fund, you must first identify your goals for the investment. Ask yourself: Is your objective long-term capital gains, or is current income more important? Will the money be used to pay for college expenses, or to fund a retirement that's decades away? Identifying a goal is an essential step in narrowing down the universe of mutual funds available to investors.

If you're looking to invest in mutual funds for the long term, equity mutual funds can be the best option. However, if you have a short-term goal, debt mutual funds that are relatively less volatile than equity funds may be a better choice.

If you have more than one goal, you can invest in a combination of equity and debt funds. For example, if you want to buy a car in the next three years, investing in equity funds may not be the best option. Instead, consider investing in debt funds that offer steady returns with lower risk.

Additionally, consider your risk tolerance when setting your investment goals. Can you accept dramatic swings in portfolio value, or is a more conservative investment more suitable? Risk and return are directly proportional, so you must balance your desire for returns against your ability to tolerate risk.

Finally, determine the desired time horizon for your investments. How long would you like to hold the investment? Do you anticipate any liquidity concerns in the near future? Mutual funds typically have sales charges, which can impact your returns in the short run. To mitigate these charges, an investment horizon of at least five years is generally recommended.

Frequently asked questions