Three Simple Steps to Selecting the Right Funds

1. Carefully analyze the fund's long-term performance. Funds of the same type can have widely different performances, depending on their managers' success in choosing investments. While it's true that past performance is no guarantee of future results, it can still be a darn good way to measure the quality of funds. And while performance should never be the only reason you invest in a fund, it is extremely important, because after all, the goal of investing is to make money! Just keep in mind, as you peruse the fund's returns, performance over a one-year period is pretty meaningless. Any investment can have an excellent or a terrible year. To effectively gauge a fund's real performance, it's essential that you look at its returns over a period of time — preferably over the last 5, 7 and 10 years.

Think of it this way: No doctor is right 100% of the time. But wouldn't you feel more comfortable going to a doctor you knew had been right 99% of the time in the past? We would, too! The same is true of mutual fund managers.

You can find a lot of this information simply by looking up quotes (using the fund's trading symbol). You can do it right at Dolans.com. Just click on the "Invest Wisely" tab, and you'll see the box in which to enter the fund's symbol. You can also check on other websites like AOL Money (http://money.aol.com), Yahoo finance (http://finance.yahoo.com), etc.

For our money, the best place to look for up-to-date information about a mutual fund's performance, as well as news and analysts' research, is the site run by Morningstar, www.morningstar.com. Most of the information on the site is free, but with a premium membership ($15.95 a month, $145 a year, or $245 for two years), you will get access to the most advanced research, news and rankings of funds as well as individual stocks.

Here's a tip for you: Morningstar will let you try the premium membership for 30 days free. If you invest with mutual funds, try it for a month and see if it's worth the investment for you.

When you are checking a fund's performance, look at the tables that show how it has fared over the last one, three, five and ten years. Look for steady performers that have consistently been among the top five funds in their category. And make sure that the performance of the funds you have selected is the performance under the fund's current management team.

2. Read the all-important prospectus: When you buy shares in a mutual fund, by law the fund must give you a prospectus. That's all well and good, but getting the prospectus after you've invested in the fund is backwards. You need to read it before you put your first dollar into the fund. Make sure you get one by calling the fund's toll-free number and asking it be mailed to you, or the quickest way to find one is on the fund family's own web site.

Dolan Ah-ha!

In 2002, Morningstar Inc., the mutual fund- rating company, changed its system so that funds are rated not in the fund universe at large, but only against other funds with similar investment styles, based on more than 50 separate fund categories. While this system is designed to give each fund a better chance of showing how it compares to others in its particular investment category, it also means that some funds that have been terrible performers could rank at the top of a badly performing category. Caveat emptor.

We know; prospectuses look complicated and scary. The type is small, they are filled with legal mumbo-jumbo, and they seem to have a lot of numbers in them. In reality — just as with almost any other type of financial document — once you've read a couple, you will see that they follow a standard format and can actually be scanned pretty quickly for the information that you need.

Think of the prospectus as a trail of clues that will tell you what's really going on in those plush offices where the fund's managers make their decisions.

There are two things you absolutely must look at in a prospectus:

• Investment Objective: You'll find the investment objective listed in its own section of the prospectus. The investment objective explains the goal of the fund. As we've talked about, the three most common goals are growth, income, and growth with income. If you're looking for more income from your investments and the fund's objective is growth, you're in the wrong ballpark. The objective also tells you how the fund manager proposes to meet that goal ("aggressively", "moderately" or "with as little risk as possible").
• The Expense Ratio: The expense ratio is listed in the fund's fee table, which shows you all the fees and expenses the fund subtracts from the fund's performance (and your investment) each year. The lower the expense ratio the better, because more profits will go to you!

In a diversified stock fund, we don't like any expense ratio that is over 1%. For an index stock fund, we recommend you look for 0.3% or less, and no more than 0.5% – 0.6% for a bond fund. We'll give you the full skinny on mutual fund fees in just a second.

The prospectus will also tell you about the fund's management (who are the advisers, and what is their background and track record?), the services provided (does the fund offer an automatic investment plan or IRA accounts?), and tax consequences (what is the likely tax impact on an investor in your tax bracket?).

3. Go beyond the prospectus and dig into the annual report. Another important document to look at before you buy a mutual fund is the annual report. When you request any prospectus, ask for a copy of the annual report as well. The annual report tells you what the portfolio manager has invested in during the year. If you compare 2–3 years' worth of annual reports, you will get a very good idea of the manager's primary long-term strategies and objectives.

Take a close look at the stocks and/or bonds that are listed. If the entire annual report lists companies you've never heard of, or companies whose business practices you dislike, this fund won't suit your needs.

The prospectus should also include information on minimum bond ratings for the bonds in which it invests. You may need to do some digging to find out the ratings, but it's easy on the web. Just go to www.bonds-online.com/Bond_Ratings_Definitions.php. If most of the bonds listed in the portfolio have a Standard & Poor's rating of BB or below, don't buy that fund.