How To Avoid The Worst Style Mutual Funds

Picking from the multitude of style mutual funds is a daunting task. In any given style there may be as many as 934 different mutual funds, and there are at least 5882 mutual funds across all styles.

Why are there so many mutual funds? The answer is: because mutual fund providers are making lots of money selling them. The number of mutual funds has little to do with serving investors’ best interests. Below are three red flags investors can use to avoid the worst mutual funds:

  1. Inadequate liquidity
  2. High fees
  3. Poor quality holdings

I address these red flags in order of difficulty. Advice on How to Find the Best Style Mutual funds is here. Details on the Best & Worst Mutual funds in each style are here.

How To Avoid Mutual Funds with Inadequate Liquidity

This is the easiest issue to avoid, and my advice is simple. Avoid all mutual funds with less than $100 million in assets. Low asset levels tend to mean lower volume in the mutual fund and large bid-ask spreads.

How To Avoid High Fees

Mutual funds should be cheap, but not all of them are. The first step here is to know what is cheap and expensive.

To ensure you are paying at or below average fees, invest only in, mutual funds with total annual costs (TAC) below 2.02%, which is the average TAC of the 5882 US equity mutual funds I cover. Weighting the TACs by assets under management, the average TAC is lower at 1.37%. A lower weighted average is a good sign that investors are putting money in the cheaper mutual funds.

Figure 1 shows the most and least expensive style mutual funds in the US equity universe based on total annual costs. Rydex provides 2 of the most expensive mutual funds while Fidelity mutual funds are among the cheapest.

Figure 1: 5 Least and Most-Expensive Style Mutual funds

Screen Shot 2014-05-14 at 2.34.19 PM

Sources: New Constructs, LLC and company filings

American Growth Fund Series Two (AMREX) and Nysa Series Trust: Nysa Fund (NYSAX) are two of the most expensive U.S. equity mutual funds I cover, while Fidelity Concord Street Trust: Spartan 500 Index Fund (FXAIX) and Vanguard Institutional Index Fund (VIIIX) are the least expensive. The more expensive AMREX and NYSAX receive my 2-star or Dangerous rating and 1-star or Very Dangerous rating respectively. The cheapest mutual funds receive my 3-Star rating. None of the most expensive mutual funds earns a better rating than the cheapest mutual funds. However, a more expensive fund can earn a better rating than a cheap fund. Quality holdings can make up for high costs.

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Disclosure: David Trainer does not currently have a position in F but may initiate a long position in the next 72 hours. David Trainer, André Rouillard, and Sam McBride receive ...

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