Gift shopping advice also can be applied to buying funds

Your Funds

Your Money

November 14, 2006|By Charles Jaffe | Charles Jaffe,Marketwatch

Most people know how to shop for gifts, to find the "right" item for that special friend or loved one.

Those same people frequently are horrible at shopping for mutual funds.

As we approach the heaviest shopping season of the year, it's clear that the same considerations that go into buying a gift also go into buying a fund. And just as the "perfect gift" often winds up accumulating dust in the back of a closet, or tossed out come spring cleaning, many mutual funds purchased with good intentions wind up being duds.

So in the spirit of the approaching holidays - and with the hope that your next fund purchase will be that perfect addition to your portfolio - here are the characteristics to consider whether you are buying a gift or a fund.

Material/fabric and cut. Before investing, you want to know what a fund is made of, and how it is styled.

It's a bit more complex than looking only at the broad asset class; take a good, hard look at the fund's investment objective. Aside from knowing whether the fund buys large or small stocks, domestic or international issues, learn if it pursues a growth, value or blended style, and how that strategy is executed. (Is it more buy-and-hold, opportunistic trading or reacting to broad economic trends?) Savvy investors want varied looks - thereby diversifying the portfolio - but they must also be comfortable with the fiber that a fund is made of.

Durability. This is where you look at track record and try to size up if the fund's performance is the result of a fundamental, long-term approach or the latest fad. Many investors buy funds on the basis of five- and 10-year results, but sell based on a 12-month stretch of bad performance; be sure to look at how the fund has done during its worst down times, so that you can decide if you will be comfortable riding out the market's rough stretches.

Need or desire? Every fund in your portfolio should have a job, whether that is bringing a new asset class and investment style to the mix, diversifying your holdings in a category where you have a lot of cash tied up in a single fund.

Before you start shopping for a fund, determine what your portfolio needs most. That will lead you to the right "department" in the fund world to get what you are looking for.

Experts at places like Morningstar and Lipper frequently say that no investor truly needs certain esoteric fund types, like those focused on single countries or specialty/niche businesses. For most investors, those types of funds represent a want or desire - they're like pursuing a current fashion trend rather than buying something with classic tailoring - raising the risk for a chance to goose returns. The key is to avoid impulse buys and to fully understand the risks that you might be facing.

Size and fit. This is less about the fund you're buying than the funds you own; make sure the new fund is a good fit. Research shows that owning four funds in one asset category creates a "closet index fund," where you pay active-management prices but get the same kind of returns you'd achieve by simply owning the appropriate index.

Fit extends to where a fund belongs. Funds that trade a lot and that throw off significant capital gains may work best in a retirement account, whereas someone investing in a taxable account and wanting to avoid a slow dance with Uncle Sam might tilt toward issues that are tax-efficient.

Price. A fund's share price is not the issue here, but its required account minimum is. Few funds have low minimums these days (for a list of many that do, check out the Web site of the Mutual Fund Education Alliance at, but plenty of funds will waive their minimums in exchange for small, regular monthly deposits.

It doesn't make sense to waste time evaluating a fund with a $25,000 minimum when you have $1,000 to invest. If you're investing on a tight budget and entry price is an object, take a peak at the fund's rules early in the shopping process.

Brand name. For a mutual fund, this might be the company or the individual manager. It's not that you shop for a fund by first limiting yourself to one or two fund companies, but once you have settled on the type of fund you want and have a few candidates to choose from, the reputation of the firm and manager will serve as a tiebreaker.

It's like going to buy a microwave and choosing between a no-name manufacturer and a name brand; once you see that the features, price and other considerations are roughly equal, you are likely to be most comfortable siding with the name you know.

Charles Jaffe, a senior columnist for MarketWatch, also can be reached at Box 70, Cohasset, MA 02025-0070.

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