Select the Right Mutual Funds for Your Portfolio

Physician's Money DigestDecember 2006
Volume 13
Issue 12

Kiplinger's Personal

Finance, Money,


Deciding your asset allocation while youare developing a balanced portfolio is justthe beginning of your financial planning.Choosing the best mutual funds for your portfoliois the next of many tasks in this process thatrequires due diligence. Some people simply cullleading magazines such as or for their recommendations.While these publications certainly providesome good ideas, you should first determinewhether you want to buy actively managed fundsor passively managed funds.

•Active vs passive funds. In an actively managedfund, a manager or group of managers activelyreviews and analyzes the securities markets andselects securities that they believe will outperformtheir relevant benchmark over time. For example,if you choose an actively managed fund that investsprimarily in large US companies, the manager'sgoal—and your expectation—might be that thefund will outperform the S&P 500 Index, which isa recognized benchmark for large company stocks.As an alternative, you might choose a passivelymanaged fund such as the Vanguard S&P 500fund, where Vanguard simply hires a computerprogrammer to buy stocks that replicate the S&P500 Index. As a result, Vanguard can keep fundmanagement expenses low (eg, 0.18% annually vs0.95% for the average large cap fund). Using passivefunds has the added advantage of minimizingthe need for detailed research on your part. Yousimply buy an index fund for each category youneed. Both active and passive funds have benefits,and it's important to decide what fits your goals.

•Past performance. If you choose to useactive fund managers, your research shouldinclude comparisons of the fund's year-by-yearperformance vs the year-by-year returns of itsappropriate index benchmark. What you are lookingfor is consistency of performance vs the index.Simply looking at 3-, 5-, and 10-year total returnscan hide the fact that the fund hit a couple ofhome runs that skewed its performance over aperiod of time. Also, be sure to remember that youare investing with a particular manager, so reviewingpast returns for a fund whose current managerdid not produce those returns should be viewedwith a skeptical eye. The same holds true if a managerleaves a fund in which you are invested.

When researching fund managers, ask yourselfthe question, "Does their security selection processmake sense to me?" If the manager cannot articulatea well-defined process, performance is likely tobe inconsistent at best. You should be able to findthis information in the fund's prospectus.

•Research tools. To help you in your quest forlong-term top-performing mutual funds, a good researchsource is the Web site Morningstar ( The section on funds allows youto sort top fund performers by category over varyingtime periods. Keep in mind that you should payclose attention to fund expenses. In order to preserveyour investment returns, you will want thefund fees to be low unless there is a compelling reasonto pay more than average.

Stewart H.Welch III, CFP®, AEP, is the founder of the Welch Group,LLC, which specializes in providing fee-only wealth managementservices to affluent retirees and health care professionals throughoutthe United States. He is the coauthor of J.K. Lasser's New Rulesfor Estate and Tax Planning (Wiley; 2005). He welcomes questionsor comments at 800-709-7100 or visit This article wasreprinted with permission from the Birmingham Post-Herald.

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