Sorting through your list of 401(k) options or looking at ads for mutual funds or exchange-traded funds (ETFs), you may feel overwhelmed by all the choices. But knowing how to approach basic fund analysis can make the universe of fund options a little less daunting to navigate.
Let's say you hear about a broad market mutual fund that’s been performing well. How do you analyze the security to determine whether or not it’s appropriate for you? You can start by taking note of the ticker symbol, so you can locate the fund on an investing website such as Morningstar or Yahoo Finance. These sites can provide detailed breakdowns of many fund characteristics. Here are some of the useful details you’ll find and what they mean:
The style box tells you the average size of the companies within the fund and it also positions the fund on the growth vs. value spectrum. The companies are usually described as either "small," "mid," or "large" cap. This is important data because a well-diversified portfolio will often have exposure to all three of these categories. The valuation spectrum is important because some investors maintain a strong preference for growth or value depending on their specific goals. Bond funds have style boxes as well, but rather than size and valuation, they express quality and interest rate sensitivity, which are two of the primary concerns of bond investors.
Asset Allocation and Sectors
While the style box can provide a quick reference point such as "large-cap growth" or "small-cap value," you may want more detail about exactly what you’re buying. The asset allocation chart (sometimes a pie chart) will show you what percentage of the fund is in cash, domestic stocks, international stocks, bonds, and alternatives. This is important because if you are trying to maintain a certain percentage of stocks and bonds in your portfolio, you'll need to know the allocation breakdown of each fund you own.
The sector breakdown provides details about which part of the economy you are investing in, such as technology, healthcare, financial services, and consumer cyclicals. This is critical information for reaching diversification goals because some sectors of the market don't correlate very closely with others. If you underweight or overweight specific market sectors, that could disrupt your portfolio, leading to undesired results.
Yield and Distribution History
Income is a top priority for many fund investors, especially those who are at or nearing retirement and need to draw some portfolio income to supplement their other income sources. The yield figure provides a quick glance at what the fund is paying, generally expressed as an annual percentage such as 2.72% or 1.25%. With stock funds, the yield is an average of dividend payments. With bond funds, the yield is an average of interest payments. Blended funds may include both. If you are an investor purchasing securities for income, viewing the distribution history can provide useful data about the regularity of the payments and the types of distributions. For example, a mutual fund can distribute not just dividends and interest, but also capital gains, which could have tax impacts.
The bull market of the past six years has taught many investors to focus on fees when selecting investments for portfolio inclusion. While you can't control the trading price of the stocks and bonds within a fund, you can choose to pick funds with lower fees. Mutual funds and ETFs have published expense ratios that show you what it will cost on an annual basis to hold the investment. Any finance portal or a visit to the fund sponsor's website can provide these figures for you.
These fund characteristics are just some of the better known dimensions that you can look at to learn more about a fund to determine whether or not it fits within your overall portfolio. When researching funds online, there are other useful data points you can view, such as the size of a fund, the average volume it trades each day, and the management tenure.
Having a better grasp on how to analyze investment options can improve your knowledge as a consumer and lead to more appropriate decisions for your portfolio. It could also save you money in situations where you are comparing similar investments with differing expense ratios. If you give real thought to your time horizon and goals, and couple that with better investment analysis and security selection skills, your portfolio should benefit in the long run.
 Cox, Jeff: The Next Big Investor Challenge: Correlation: March 15th, 2014. http://www.cnbc.com/2014/03/14/the-next-big-investor-challenge-correlation.html