How to choose a mutual fund

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Choosing mutual fund investments from the thousands of fund offerings available can be daunting. With so many different categories of funds and fund families, it may make sense to work with your financial professional. Here are some steps experts recommend you consider when selecting investments.

Assess your investment objectives

When you set out to select a fund, your first task is to formulate your investment objectives and identify your time frame. For example, you may plan to buy a new house in three years, to invest for your children's college education in 15 years, or to fund your retirement in 30 years.
Generally speaking, the longer your time horizon, the greater your tolerance for risk. If you have an investment time frame of more than 10 years, you may want to take a higher degree of risk and position yourself for higher earning potential over the long term by investing more aggressively in growth-oriented stocks. On the other hand, if you know that you will need the money in less than five years, you may want to allocate your portfolio towards more conservative, income-producing securities such as high-dividend stocks or short-term bonds. Footnote 1

Match your goals with funds' investment objectives

The next step is to identify which types of mutual funds match your investment goals and risk tolerance. With the thousands of mutual funds now available, you certainly have plenty of options to choose from, whatever your goals are. But don't be confused by the seemingly endless differentiation of the mutual fund industry, which can be boiled down into a few large groups. In terms of investment objectives, stock funds, for example, include "aggressive growth," "growth," and "growth and income," depending on the kinds of securities they hold. Each group of funds can further be categorized by risk level, as "above-average risk," "average risk," or "below-average risk."
A number of information sources such as Standard & Poor's, Morningstar, Lipper Analytical Services, and Value Line (available online and at most local libraries) can help you understand mutual fund investment objectives and risk levels. Standard & Poor's, for instance, arranges U.S. stock funds into five major groups, providing for each fund investment style, performance and risk analysis, and an overall risk-adjusted rating in relation to other funds in the same category.
Once you have identified the fund categories that seem appropriate to your investment objectives, you will want to take a close look at individual funds in each of the categories. Performance over a period of time is usually an important factor, but not the only consideration. Other factors may include the consistency of fund management, investment policies, and variability in returns over time.
In addition to published sources of mutual fund comparisons from Standard & Poor's, Morningstar, and Lipper Analytical Services, and personal finance magazines, you will also want to read the material available from the fund company you are interested in. Most important, you'll need to review the prospectus, which is available free by contacting the fund provider. Fund contact information is available through major financial publication websites including The Wall Street Journal, The New York Times, and Yahoo!
A fund's prospectus describes the fund's investment objective, types of securities it invests in, and the risks these investments involve. The prospectus is intended to help you to understand exactly what you are investing in. A prospectus of an aggressive growth fund may tell you, for example, that the fund invests in small and often volatile stocks, that it could use products such as derivatives to hedge or to maximize investment returns, and that the fund involves above-average risk.

Equity fund categories

  Fund category Risk Level
Domestic equity Aggressive growth High
Equity income Medium
Growth Medium
Growth and income Medium
Small company High
Industry sector High
International equity Diversified emerging markets High
Foreign stock High
World stock High

The hunt for top performers

Fund prospectuses also tell you the funds' performance, fees and expenses, and other information that investors should have when looking for mutual funds. Performance over the time frame that you are investing for, with an appropriate level of risk, is the bottom line. So, when you hunt for top-performing funds, don't focus on the funds' latest performance only.
Instead, look for funds that consistently provide above-average investment returns in the same fund category for the past three, five, and 10 years. Lower volatility is evidenced by funds that are ahead of their peers during bull markets, while not falling more than the averages in bear markets. Past performance is no guarantee of future results.
Compare the annual percentage returns of a fund with its major benchmark index over the same period. For example, compare the performance of diversified stock funds with the S&P 500 stock index, or bond funds with Bloomberg Barclays bond indexes. Mutual fund performance benchmarks, which average the investment returns of similar funds, are published each quarter in major financial publications or are available through their websites.

Fixed-income fund categories

  Fund category Risk Level
Government bonds Treasury Medium
Mortgage-backed High
Corporate bonds High quality Medium
High yield High
World income High
Municipal bonds General obligation Medium
Single state Medium
Fees and expenses that funds charge investors vary widely from one fund to another. Some funds impose a sales charge (front-load) when you buy shares; others impose an exit fee (back-load) if you sell shares before a specified period of time. There is also a large number of no-load funds available. In many cases, you may be better off to work with a broker or investment representative and pay a sales load; however, if you are working with a qualified financial planner, he or she will be able to help you select appropriate no-load funds for your portfolio. In general, there may not be a significant difference between load and no-load funds in terms of performance. For a truly superior fund, however, it might be worthwhile to pay a load, particularly if you plan to stay with the fund for a long period of time. In addition to sales charges, mutual funds charge various management fees. Everything else being equal, lower total fees and expenses result in higher returns.

Footnote 1 These allocations are presented only as examples and are not intended as investment advice. Please consult a financial professional if you have questions about these examples and how they relate to your own financial situation. The investor profile is hypothetical.

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The material was authored by a third party, DST Retirement Solutions, LLC, an SS&C company ("SS&C"), not affiliated with Merrill or any of its affiliates and is for information and educational purposes only. The opinions and views expressed do not necessarily reflect the opinions and views of Merrill or any of its affiliates. Any assumptions, opinions and estimates are as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is in your best interest based on your particular circumstances and, if necessary, seek professional advice.

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