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Online Investing Hacks by Bonnie Biafore

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Hack #65. Evaluate Mutual Funds

Check key fund measures to find funds that are likely to outperform the competition.

Let’s face it: most funds don’t beat the market. With more mutual funds available than individual stocks, how can you know which ones are the best? You must hone in on the factors that lead to outstanding performance, such as management tenure, low expenses, past performance, and low portfolio turnover.

The Index Advantage

There are two major types of mutual funds: index funds and actively managed funds. Index funds mirror the investments represented by market indexes, some tracking broad segments, such as the total stock market, while others focus on more narrow niches, such as small-cap growth companies. Actively managed funds, on the other hand, hire hotshot portfolio managers who aim to beat the market with their own special brand of buying low and selling high.

The indexing advantage rests on two pillars: low costs and market efficiency. The task of managing an index fund is simpler than that of building a market-beating portfolio, so index fund costs are lower. Because costs cut directly into a fund’s performance numbers, lower-cost funds carry a built-in advantage. In addition, index funds don’t trade as much as actively managed funds, because the stocks in an index don’t change very often.

Tip

Efficient market theory holds that the total return of the stock market equals the return of all investors. Therefore, if some investors outperform the market, others must ...

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