The Mutual Fund Funnel

A financial plan should include an investment management section which outlines your strategy for managing your investment portfolio. First and foremost, this section should identify an appropriate asset allocation mix between stocks, bonds, and cash. This mix should coincide with the investors’ risk tolerance. Next, the plan should determine a diversification strategy that outlines how much of the portfolio will be invested in certain asset classes, such as large cap stocks, international bonds, and money markets.

However, after we determine how much of our portfolio is going to be invested in each of these asset categories, we still need to identify high quality investments. This is where the mutual fund funnel can be of use. There are currently over 26,000 mutual funds. How do we know which ones to trust?

Start by only considering funds that invest in the asset category you are looking for. In our example, we’ll assume we are looking for a large cap value fund. Of the 26,000 funds available, only 1,076 invest solely in large cap value stocks.

Of course, we want a mutual fund that is going to achieve superior investment performance. As we all know by now, past performance is not an indicator of future success. However, if you were looking for a coach for your basketball team, would you want a new coach with an unproven track record, or would you jump at the chance to hire Phil Jackson? We can further narrow our search by looking for a fund that has achieved above average performance over 3, 5, and 10-year investment horizons. This reduces the number of funds under consideration to only 143.

What are the remaining steps of the mutual fund funnel? Click the link to visit the blog of one of Net Worth Advisory Group’s financial planners to learn how to narrow the number of quality mutual funds to just 9.