How to Rate Investment Companies

Read the Prospectus before Investing in a Mutual Fund

The investment company is the legal and operating "ownership" of a mutual fund. It is the investment company that is responsible for all personnel decisions including the portfolio and analysis teams, advertising, legal and corporate responsibilities. It is the organization where funds are paid by investors. Investment companies may be publicly or privately held.

Difficulty:

Moderate

Instructions

Things You'll Need

• Internet access

Rating the Investment Corporation-Investment Results

1. Know that performance of the mutual fund is directly tied to the quality of the investment company. Never compare performance in an absolute sense. Judge results by comparing the investment company fund return to similar funds in the same purpose, type of assets, size, and investing style. Comparing anything else says more about where you chose to invest rather than the performance of the investment company fund.

2. Review SEC (Security and Exchange Commission) filings and study the management discussion of operations. Look in particular for regulatory action, lawsuits and negative legal comments about the fund operations. Take any regulatory action as poor management and avoid the investment company and its funds. A link to the SEC appears in the Resources section. Any compliance failure should also give pause to investors because it implies lax management.

3. Study the expense ratios and portfolio turnover ratios for your investments. This is the one area the portfolio manager and the investment company directly control. The larger the fund, the smaller expense ratios should be on a per asset basis. High expenses come directly from your pocket. Performance and total return are affected by expenses.

4. Remember that just a 3 percent difference in annual returns for two funds for 20 years represents a doubling of value of one fund over another. Investing is difficult. Remember that the investment company makes money from having more shareholders. Family of funds were developed so investors may move between stocks, bonds and money market funds under the same investment company auspices. The larger the fund, the harder it is to diversify because the fund can only buy more of the same securities in the portfolio. Thus the fund begins to resemble the market that you are paying for the manager to outperform. Large funds necessarily can only approximate the market. Look for funds that are small with seasoned management teams doing the investing.

5. Ratings of funds is easy to find. Morningstar, Yahoo, MSN and the financial dailies and weeklies all have their own tools for measuring performance. Indirectly, this is the best measure of an investment company as performance brings more investors while stabilizing existing investors. Management companies that also run money funds and have extensive bond portfolios are inherently worth more because those investors tend to be more stable.

Tips & Warnings

• Decide your investment goals and then decide what sectors to invest in. Only then can you choose the highest rated funds available. Performance is return minus expenses. Trust funds that keep expenses low.

• Read the annual report or fund prospectus and look for material changes in management, financial condition or legal status. Avoid funds that have violations of the Investment Company Act of 1940.

Resources

• The Investment Company Institue Webpage
• Morningstar Investment Survey Homepage
• Investment News and Links