August 2002 Bulletin

Comparing mutual funds

Learn the basics to choose wisely

By Joel M. Blau, CFP

The universe of mutual fund choices is overwhelming. With so many different funds competing for investors’ dollars, it is very easy to either chase the fund with the highest return or leave the decision to a professional advisor. And, in today’s turbulent financial environment it can be a daunting task to try and decide on a fund that is right for your particular investment needs. However, if you take a moment to learn the basics of how to compare mutual funds, you’ll be armed with the ability to choose wisely for yourself, or to intelligently examine the advice of your financial professional.

Volumes have been written on the many characteristics that differentiate mutual funds. Understanding three fundamental concepts will help simplify the complex choices: asset class, management style and expenses.

Asset class

Asset class is often described in the title of the fund and defines the underlying securities the fund purchases on the investor’s behalf. For example, a fund can be comprised of stocks, bonds or real estate investments, to name the largest and most common fund holdings. Within these classes is a dizzying array of distinctions. Stock funds can be further categorized according to the location, size and sector of companies held. Roughly the same distinctions hold true for bond funds.

The main geographic categories for mutual funds are domestic, foreign/international and global. Domestic funds such as Oakmark Select purchase shares of companies headquartered in the United States. Foreign funds like Artisan International* purchase shares of companies operating anywhere outside of the United States, while global funds such as Janus Worldwide tend to invest in a combination of companies throughout the world. Of course, these categories themselves have varying distinctions.

Other basic asset class distinctions

Company size and sector are other basic asset class distinctions. Company size refers to the market capitalization. Market cap is a simple calculation: multiply the total number of outstanding shares of a given company by its stock price.

Mutual fund market cap distinctions are commonly divided into three categories: large-cap, mid-cap and small-cap. Large-cap typically refers to companies with a market cap exceeding $8 billion, "mid-cap" to companies in the range of $1.25 billion to $8 billion and "small-cap" to those under $1.25 billion. These are the guidelines employed by the Royce Low Priced Stock Fund.** There are varying schools of thought regarding the importance of diversifying your investment portfolio among the different market cap sizes.

Sector-specific funds are another subcategory to consider. Sector funds purchase stocks of companies in a particular sector [business category] such as retail or finance. For example, an energy fund may buy shares of companies that run hydroelectric power plants, build natural gas lines or operate oil refineries. Sector funds can be broad, as in "finance," or very narrow, as in "South African precious metals." Sector funds, such as the Evergreen Health Care Fund, provide exposure to a very narrow segment of the overall market and thus should be well researched and fully understood.

Management style

With regard to management style, the overall distinction is an either/or scenario: active or passive. Index funds, such as the Vanguard Index 500, are by nature passively managed, as there is no portfolio manager choosing specific stocks based on his or her research. Instead, shares of companies are bought and sold only when the index itself changes its overall configuration. Investors use passive management to achieve broad diversification and cost effective management. Passive management is essentially a buy and hold strategy that can result in low trading costs with the added attraction of significant diversification.

An actively managed fund like Ameristock holds securities chosen by a paid portfolio manager(s) who chooses and monitors individual stocks based on an investment philosophy. Investors choose actively managed funds if they believe the fund manager will be able to outperform a corresponding index. Keep in mind that, with any actively managed fund, the challenge is to find a good manager based on demonstrated skill and sound management style. Also, since actively managed funds employ professionals to choose and monitor stocks, management costs and trading costs can be significantly higher than passively managed funds.


Finally, an important aspect of mutual fund investing is expense. Funds are labeled as either "load" or "no-load" based on the existence of sales charges. "Loads" are basically the compensation an investor pays for the advice to buy a particular mutual fund. Load funds are typically purchased via brokers, commission-based financial advisors and banks. A fund considered "no-load" simply does not charge a sales fee. Yet "no-load" funds are not "free." Regardless of whether a fund is "load" or "no load," all mutual funds incur ongoing expenses that are passed on to the shareholders. These charges take the form of management fees and are included in the fund’s expense ratio. The expense ratio is a widely used figure that reflects the overall cost to the investor of holding that mutual fund. So when comparing mutual funds, assess not only the sales charges but also the overall expense ratio of the fund in order to accurately predict the expenses you’ll pay over time for owning your shares.

Understanding the concepts of asset class, management style and expenses will help you, as an individual investor, to choose among the thousands of mutual funds available today. Even if your financial professional recommends funds for you, understanding these three concepts will enable you to ask the right questions about the investment.

For more complete information, including fees and expenses on these funds, contact your financial advisor for a prospectus. Or contact the fund company directly. Read the prospectus carefully before you invest or send money.

(Note: The mutual funds mentioned in this article are used for illustration purposes only and are not to be considered to be investment recommendations.)

* International/ foreign funds–Investors in international securities are sometimes subject to somewhat higher taxation and higher currency risk, as well as less liquidity, compared with investors in domestic securities.

** Small-cap funds–Small-cap stocks may be subject to a higher degree of market risk than large-cap or more established companies’ securities.

Joel M. Blau, CFP, is president of MEDIQUS Asset Advisors, Inc. He can be reached at (800) 883-8555 or

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