When one starts to screen mutual funds for investing, the following 5 must be set before any additional criterion is applied to the screen.
- Set front load = 0. Yes, this should be the first selection criterion. There is no need to throw your mutual fund investment in a hole to begin with outrageous 5% or more front loads. This should remove all class A shares from your result set.
- Set deferred Sales Charge = 0. When your pie grows, keep it entirely. Do not give up part of it in the sales charges when you sell. This takes care of the class B shares from the result set.
- Say no to 12b-1 fees. 12b-1 fees include the charges of marketing and selling the mutual fund. There is no need to pay the marketing fees for the fund family. If the fund is good, people will find it. If you believe in efficient market theory then you have to believe that no good fund goes unnoticed. The new assets will surely flood the better performing fund. Removing 12b-1 fee funds from the selection should remove all class C shares from the result set.
- Keep expense ratio less than 1.25%. Although industry average expense ratio of the mutual funds is around 1.46%, I suggest you keep it less than 1.25%.
- Find funds with lower turnover. The mutual funds with higher churn rates have higher capital gains taxes that must be paid to government in taxes each year. This reduces the overall return of the fund.
After applying these 5 criterions, go ahead and add others as you may. This should be a good standard starting point. There is no magic formula out there for finding great mutual funds. We don’t know right now which mutual funds will perform better from here in out. But, I believe these screening criterias will remove some definite bottom feeders from your list.
All disclaimers apply.