By Tom Halloran
When it comes to making investment decisions and preparing for retirement, many investors fall prey to snap judgments based on a mutual fund's star rating or simply become overwhelmed by information overload. The good news is that there is a middle ground that can help you navigate your options and make informed decisions. The following six considerations -- all of which can be easily found on a Morningstar (MORN) fund report, can help you assess your investment options.
1. Read up on your funds' portfolio managers. The captain of a ship controls the fate of passengers just as a portfolio manager of a mutual fund is in control of the individual investor's financial journey. Therefore, it is important to review the manager's tenure and the performance of the fund since they've been the "captain" of the portfolio. If performance has steadily improved or declined over the course of their tenure, that may tell you something important.
With a bit of digging, you'll find details on a fund manager's experiences and background that can be telling. If the manager has overseen the fund for less than two years, I like to look into their prior experience managing money in the same investment category (for example, large cap, small cap, bonds, real estate investment trusts) as well as past investment performance. If they were successful in a similar category, it should give you confidence that they have the experience necessary to "steer the ship" on the fund they currently manage.
2. Understand the asset allocation of your investments. You should understand your portfolio's asset allocation (stocks, bonds or cash) for each fund in your portfolio. In both good and bad market conditions, portfolios can drift into more aggressive allocations than previously established when you first began investing. The key is to have a mix of stocks, bonds and cash within a portfolio that matches your risk profile/tolerance, financial goals and time horizon.
%VIRTUAL-WSSCourseInline-792%3. Look at a fund's top holdings. The top holdings can be a great barometer for how the fund will perform in different market scenarios. For example, you may notice that a particular fund has several technology stocks within its top 10 holdings. In a market where technology stocks are showing strong performance, your fund is allocated to perform similarly. Unfortunately, it can also have the opposite effect. If technology stocks "trade in the red" even on an up-day in the market, you could see your holdings in the fund perform flat-to-down for that session.
4. Dig into new holdings and largest position changes. Exploring a fund's new holdings and largest position changes will illuminate the number of shares that have been added or subtracted since they were last reported (typically every three to four months). Based on that information, you'll better understand how the fund manager is investing new cash into the fund. Finally, you might even want to put a few of these companies on your personal "watch list" to follow in the event you decide to buy an individual security as well.
5. Assess your portfolio's expenses in relation to its returns. All too often, investors will look at total return and not understand the relationship of the fund's fee to that return. For example, you may have a fund with above-average expenses that is delivering strong returns, while a low-cost fund may be underperforming. Also make sure to review specific fund information to determine how the fee level of each fund stacks up against its peer group.
This will ensure that you aren't overpaying for below-average performance, as there is a balance to consider between expense and results. The lowest-cost funds are by no means the best performers just as the most-expensive funds aren't necessarily the worst performers. It's about results that translate to growth within the parameters of your goals and time horizon. Also remember that it's about overall value for your entire portfolio, not only for a single fund.
6. Know the turnover ratio on a fund. This ratio is important as it allows you to see how often the portfolio manager changes holdings within the fund. A high turnover ratio isn't necessarily a bad thing, as some managers do trade more than their peers and market conditions may dictate more trading at times. There are near-term potential downsides of high turnover ratios: They may increase the likelihood of potential capital gains distributions and also, trading costs come at an expense.
Most managers are focused less on investing for tax efficiency, and more on maximizing the fund's total return. Although it might be disappointing to pay taxes on capital gains outside of your tax-deferred accounts (individual retirement account, 401(k), etc.), having more money is a nice problem for any investor. That said, if capital gains are a significant sore point for you, explore funds that focus specifically on tax efficiency. They are out there.
It may be tempting to judge an investment opportunity by its Morningstar rating alone for simplicity's sake, but there are other key indicators of a fund's potential success that can help lead you to a more secure retirement. By keeping these six ideas in mind, you can better dissect your investments, looking inside the numbers and beyond the star rating.
Tom Halloran is president of Voya Financial's closely aligned broker-dealer, with over 2,400 registered representatives who provide education, financial planning and a broad range of personalized asset accumulation, protection and distribution solutions to advance the retirement readiness of Americans.
By Tom Halloran