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Jan. 9, 2018, 3:32 p.m. EST

Mutual funds: Everything you need to know

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By Jonathan Burton, MarketWatch


When choosing mutual funds, few aspects are within investors’ control. Future performance isn’t one of them. But expenses, risk, manager tenure and tax-efficiency are qualities that can be judged before you buy.

Experts say you need to look beyond just performance. You need to understand what will make a fund do well in the future and why it belongs in your portfolio.

What to watch FOR:

Index funds, which track a basket of stocks, are generally low-cost options intended to provide market-like returns. Active management, in contrast, relies on a professional’s stock-picking in an effort to beat a market benchmark.

Yet an actively run stock fund is much more than an expert’s collection of chosen stocks. You’re putting money behind a manager, a fund company and a philosophy about investing, trading, taxes and risk. But what makes a fund manager think they can outperform?

Answers to these questions and others can be found, easily enough, on fund-company Web sites, where it’s typical to find quarterly manager commentaries. Some managers are quite forthcoming about the reasons for their investment decisions and what they’ve learned from any mistakes.

All things being equal, such open-minded fund managers are keepers for your short list. Honest and timely messages from managers show respect for shareholders that likely extends to other important, investor-friendly attributes: low expenses, investment consistency, strong research analysis, sound corporate governance and managers’ own money on the line.

The ‘Lazy Portfolios’ strategy

A basic and very simple strategy that works well for many investors is The Lazy Portfolio: A simple, well-diversified portfolio ranging from just three to 11 low-cost, no-load index funds that will create a long-term winner through bull and bear markets. And you do it with no market timing, no active trading and no commissions. See MarketWatch’s Lazy Portfolio section now for detailed information and total annual returns, as well as links to eight Lazy Portfolios.

What to WATCH OUT for

Paying too much: You have to care about expenses. They are the most predictable characteristic of explaining future returns of funds, experts say. And expenses are a more reliable signal than past performance.”

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How to pick the right mutual funds for you

Choosing the right mutual fund is different from choosing stocks, because you're effectively choosing a money manager rather than a management team. Controlling costs is key to successful fund investing.

It can’t be said enough: with funds, costs matter. Annual expenses eat into total return, year after year. With high-cost funds, you pay more and pocket less. Moreover, studies show that low-expense funds are more likely to outperform their costlier counterparts over time.

Taking excessive risk: No risk, no reward, as the old saying goes. Maybe you’ve found an attractive fund with a great multiyear track record. But just how attractive the fund is will be determined by how the manager generated that return.

Better to invest with a manager who delivered superior gains with minimal risk.

In looking for how returns were achieved, check the fund’s annualized results for unusual highs and lows. Then compare those figures with its category peers.

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