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Some 95 million individuals in the U.S.-owned mutual fund industry last year accounted for about three-quarters of the total $6.3 trillion invested in funds at the end of 2002, according to the Investment Company Institute.
Offering the average investor instant diversification and low-cost access to professional money management, it's no wonder mutual funds' popularity has soared. But with more than 8,000 funds to choose from, how do financial advisors decide what to put in their clients' portfolios?
"Choosing mutual funds is client-centered," says Linda Barlow, a CFP in Santa Ana, Calif. "Each portfolio is based on the individual - there are no cookie cutter portfolios."
The funds depend on the client's circumstances and needs, Barlow adds. "You have to look at the time horizon, the risk tolerance, and determine how much to put in each asset class and sub-asset class. It also depends on whether the funds are for a taxable retirement account or not."
Selection Process
When it comes to evaluating funds, there are no hard and fast rules. Like cooks, most financial advisors seem to work with many of the same basic ingredients, but each has their own personal, fine-tuned recipe for selecting funds. For most, it's a mixture of performance, management style and tenure, fees, expense ratios, size of assets, and tax efficiency.
"Our first screen is for top quartile performers in their peer group," says Jack Harmon, CFP, of Harmon Financial Advisors in Atlanta. "Nowadays, we place the largest weighting on the top quartile performance for the last five years. We think three years is an aberration, especially as a result of what's happened with the market. It doesn't give a true measure of the manager's expertise. We also want to know how the manager is performing currently, so we also look at the top quartile for the past year."
Charles Hughes, CFP, of CG Hughes Co. in Bay Shore, N.Y., says that he looks for funds in the upper quartile, and prefers to go back five years, even ten years if a fund has a track record that long. "What's important is looking at what type of investment cycle we've been through during that time. If you're looking at a period when stock prices were only rising, it won't give...