Best Investments for 2012 - How Do you Pick 401k Mutual Funds

Mutual funds and 401k investing is the primary way that most folks experience the stock market and plan for retirement. Though I love buying and selling individual stocks, it’s clar that most people don’t have the time or the brainpower to look beyond mutual funds — to say nothing of the added risk you take on when trading a diversified mutual fund investment for an individual stock. So it’s no surprise that one of the most frequent questions I get is about picking the best mutual funds within your 401k. I’d like to tackle that topic today, but broaden the discussion to picking the best mutual funds overall – whether you have a limited menu from your employer’s 401k retirement plan or a broader IRA account with access to more options. When evaluating your 401k and mutual fund options, you should check out the following factors: Did the fund beat the S&P 500? This question matters on two fronts. First, did it beat in the last year? Secondly, did it outperform in the longer term, like across the last five or 10 years? (Surprisingly most managers DON’T … here’s the disturbing proof.) What’s the expense ratio? This is the amount of your returns that the fund shaves off. 1% sounds like a reasonable expense, but what if you only get 3% in annual returns? Well, your expenses shove that down to just 2%. Giving up 1% in returns every year adds up dramatically over a decade or two. If your fund has an expense ratio higher than .75% or 1% it better deliver impressive returns to be worth it. How long has the manager been there? If the guy moves around a lot or has only recently been put in charge of the fund, you really can’t credit him with any of its success. That would be like saying it doesn’t matter whether Steve Jobs is leading Apple Inc. (NASDAQ:AAPL) or not – it matters a great deal. That’s not to say a different manager can’t prove himself over time, but don’t be his guinea pig. Less than a year or two is a warning sign. Another good rule of thumb is the Morningstar rating. This is a firm that specializes in ranking the best and worst funds. Anything that’s a four or five star is typically a solid fund overall. This mutual fund research firm is a great resource, though obviously you shouldn’t rely too heavily on their evaluation alone. So what if you want to check these three metrics on your own? My favorite one-stop shop is Fidelity … If your mutual funds aren’t in the Fidelity family, don’t worry – it offers info for ALL funds. Well, over 1,700 funds anyway. Just type in the name of your fund under the “search” functionality at the very top of the page in the green bar, and then click on the fund you want to research to get an in-depth summary of the investment.
Let’s use a sample summary of Best Investments for 2012 - Fidelity Contrafund (MUTF:FCNTX) as an example. Click on the inset image to view an annotated look at the page, and how to find the relevant information. Click to EnlargeFor returns, Fidelity shows actual percentages for various time frames – and plots a neat graph to the right. I like this approach because it appeals to both the data-heads and the visually minded investor. A quick look at the graph shows you Contrafund would have turned $10,000 into $20,000 in just 10 years. If you want to know what the precise annual returns were in that period, they are provided at the left (7.54% annually — very nice considering the turmoil of the last decade). The graph also allows you compare it to other stocks and mutual funds (compare it to the S&P 500 by typing in SPY, the ticker symbol for the Best Investments for 2012 - SPDR S&P 500 ETF (NYSEARCA:SPY). For expense ratio, look at the bottom of that summary information, under the returns. Expenses of 0.92% seem high, but the performance is there so maybe you don’t mind paying a bit extra for this fund. For manager tenure, look under the graph at the right and click on the name or names. A pop up will give you the info you need. Danoff has been around since 1990. So what if your expense ratio is too high or the performance is bad? Well, if you have a limited menu of 401k options than just type in the other funds available to you and do some basic comparisons. If you really want to boggle your mind at the universe of funds out there, you can use their sophisticated Fidelity Mutual Fund Evaluator tool to filter by asset classes (stocks or bonds) by expense ratio or anything else. At any rate, my three pointers are not the end-all, be-all of 401k investing. But they are a good place to start, and I hope this is helpful to mutual fund investors and folks worried about their 401k retirement plans. If you have any follow up questions, please drop me an e-mail via editor@investorplace.com and I will be happy to go into more detail.