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When buying mutual funds, use the F.I.T.T method.

Contributed by Ken Ennis is a contributor to the Fund.com Expert’s Desk and Managing Partner of ESE Advisory Group LLC.

F = FEES. Most mutual funds have fees, and most add them up so you can see what you’re paying as an overall percentage of your investment. 1.25% for stocks funds and .50% for fixed income funds are fairly reasonable expense ratios. If the fund you’re interested in has higher ratios than those, ask your advisor why. Then ask whether he/she can recommend cheaper alternatives — and regardless of their answer, keep looking yourself.

• Remember to multiply the % in the expense ratio by the amount of money you’re investing. 1.25% may not sound like a lot — until you attach it to your hard-earned $100,000 investment. At that point, 1.25% becomes an annual fee of $1,250 per year for a single fund. That may make you uncomfortable.

I = Investment Strategy. Explanations of a fund manager’s strategy will be found in the fund’s prospectus, and in fund reports provided by reputable fund data suppliers like Morningstar or Lipper. Basically, you’re looking for two things:

1) does the fund “walk its talk”? I.e., does it in fact invest the vast majority of its assets in the asset class that’s in its title. For example, if you invest in the “ABC Small Cap Growth Fund”, you’d like to see 90-95% of that fund invested in small cap growth stocks. If you see less, buyer beware.
2) In the case of the above, what is the fund investing in besides small cap growth stocks? Small cap value stocks or cash would be fine. Mid cap stocks, large cap stocks, fixed income, real estate – not fine. We suggest you look for another fund. If the words “illiquid” or “high yield” show up in the investment descriptions of a fund that doesn’t claim to be a high yield fund, the manager may be trying to enhance returns by tossing in investments that don’t belong. Look for another fund.

• Remember: YOU MUST understand what a fund invests in before you invest in the fund. Not doing this would be like buying a house without going upstairs or checking out the basement. If you find the process too confusing, ask your advisor to explain it to you. If you still don’t understand, trust your instincts and move on to another fund anyway – and possibly another advisor. Warren Buffett only invests in businesses he can understand; it seems to work pretty well for him.

T = Turnover. “Turnover” means the percentage of a fund’s instruments that are bought and sold within a given year. 100% is a good base turnover for an equity fund, but if it goes significantly higher than that, you risk paying higher fees (even if the fund, gulp, loses money) because there are so many trades that must be paid for. Plus, with so much turnover your capital gains taxes may be higher – even if, once again, the fund loses money overall. A high turnover fund – 200%+ — is making quick bucks on its trades. That can be fine if it’s the investment style you really want — but again, your tax bill may give you serious sticker shock.

• Remember: YOU MUST try to find a fund’s turnover numbers over the past few years to get a sense of a pattern. If last year’s number was 125% and the two years prior were 250%, buyer beware. You’re looking for consistency, and that isn’t it.

T = Tenure. As in: Fund Manager Tenure. In most cases, you’re better off with a fund that’s managed by a team, because it ensures that your hard-earned money doesn’t rely solely on one person. Five years or more of reliable tenure gives a fund’s results a degree of consistency. Of course, if a fund changes managers, don’t rule it out — the new manager maybe eminently qualified to do a fine job. Just be aware that the new team won’t have any track record in managing that particular fund.

• Remember: YOU MUST look in the prospectus for the tenure of the manager or management team. If it’s less than 5 years, move on to another fund, unless your advisor can give you good reasons to believe that the new manager is qualified and ready to go. Most people do more research before they buy a washing machine than they do before investing their life savings in a mutual fund. Shop around; this decision is too important to rush.