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There are nearly 26,000 mutual funds and ETFs available to investors today—more than the number of stars most of us can see in the night sky. We seek to keep the Upgrader Funds invested in leading funds, and sorting through the thousands of available funds and ETFs to determine which ones to own is no small task. Our screening process considers costs, diversification, risk and return. Here’s how we do it:
Avoid loads to help control costs
Nearly a third of the funds on the market are load funds, which charge a steep sales fee. This fee can discourage investors from selling a lagging fund, and the fee also eats into returns. If you invest $10,000 in a fund with a 5% front-end load fund, $500 of your investment will go to the sales charge, or load, and only $9,500 will be invested in the mutual fund. That means on the first day you own the fund, your investment is already down 5%. Noload funds don’t charge this sales fee. When you invest $10,000 in a noload fund, your full $10,000 is invested in the fund.
Seek distinct funds for diversification
We seek out distinct index funds and share classes, so that we can build diverse fund portfolios. There’s a tremendous amount of duplication in the fund industry. There are nearly 100 index funds that all track the S&P 500. If you already own SPDR S&P 500 (SPY), do you really need to own S&P 500 index funds from Vanguard and iShares, too? There’s also the issue of share classes. Many funds also have multiple share classes, each with its own ticker and fee structure. A Vanguard fund, for example, may have a share class for institutional investors, a share class for retail investors and an ETF share class. These share classes all represent the same portfolio, so there’s no need to hold more than one. When we eliminate duplicate indexes and share classes, we get down to around 8,000 funds and ETFS -- a much more manageable number.
Look for established funds & widely traded ETFs
Funds that don’t have sufficient assets can be sensitive to large inflows or outflows. Funds that don’t have a solid asset base are also at risk of being closed or liquidated. Guggenheim, an ETF provider, closed eight ETFs in 2012 due to low assets. ETFs that haven’t attracted sufficient assets and aren’t widely traded often lack liquidity. This can lead to wider bid-ask spreads, and larger discrepancies between an ETF’s price and the value of the underlying securities.
Evaluate risk & return before investing
Different funds have different risks. Diversified funds are typically less volatile than funds that concentrate in a particular area of the market so we separate core equity funds from more aggressive equity funds, such as those that concentrate in one region or sector of the market.
Once we know how much risk we are willing to take, we try to identify the best places to put that money given that level of risk by investing in funds with strong recent returns. We aim to invest in areas of the market that aren’t just in favor today but potentially remain in favor for many years.
Data from Investment Company Factbook 2014
The S&P 500 Index is a broad based unmanaged index of 500 stocks, which is widely recognized as representative of the equity market in general. The SPDR S&P 500 (SPY) is an ETF that tracks the S&P 500 index. You cannot invest directly in an index.
Diversification does not assure a profit or protect against loss in a declining market.