Choosing mutual funds over choosing individual stocks breaks down to how the funds are managed and in what sectors of the economy they are invested. As of 2010, there were 7,581 mutual funds being traded on US markets, which outnumbers the selection of individual stocks that are available. This is due to the fact that fund management businesses make guaranteed profits over managing mutual funds through investment loads and routine management fees that aren't charged on individual stock purchases. As a result, choosing mutual funds should first focus on the fees that they charge and how actively the portfolios that they represent are traded on the market to keep them in a positive growth cycle.
A starting approach to choosing mutual funds is to look for funds that have been in existence for a long time, at least a decade or more, with a history of positive growth. These types of funds are usually managed by teams or fund managers who have been involved since the start of the fund. Positive growth mutual funds are also usually diversified across wide segments of the market instead of just one market sector, like transportation, energy, or retail sales. A fund that is diversified across many sectors of the economy will have more predictable growth over time than one focused on related industries will.
Historical trends show that broad stock market returns average 10% a year for individual stocks and 13% a year for mutual funds, so choosing mutual funds should focus on those that can show an average return rate of 13% over several decades of market fluctuations. It is also important to distinguish between what a fund's annualized return rate is versus investor returns. The annualized return rate for a mutual fund is its percentage of growth overall, which can often look very positive, but the investor return rate is the actual percentage of growth after fees charged to the investor have been subtracted and this can be 10% lower than the stated fund growth rate.
Mutual fund fees include the sales charge or load for the purchase of the fund and a purchase fee for when an individual invests more money into the fund. There are also deferred fees for when the investor sells his or her interest in the fund and a redemption fee to sell part of the fund. Mutual fund management teams can also lump on other fees, such as exchange fees for transferring fund assets within the fund group or account fees if the investment does not reach a minimum dollar value. Aside from those traditional fees, the management team for the fund will charge investors for annual operating expenses and management fees as well. All of these charges can take a mutual fund that is performing positively in the market into negative territory for the individual investor, so they must be examined carefully before buying into the fund.
High turnover rate growth funds can often show percentage gains of 100% or more in a year, but choosing mutual funds should never be based on a single year's performance. If the track record of the fund is targeted towards growth, it encourages investors to put money into it during high-growth periods, but these periods are often based on short-lived market trends and are offset by many years of negative performance. Choosing such funds requires that the investor keep a close eye on how they are performing, as volatility will cause some to trade high and low on a quarterly basis. This goes against the basic idea of investing in a fund in the first place, which is done with the intent that it will be professionally managed without the need for close scrutiny by each individual investor. Investment advisers suggest choosing mutual funds that are well-established and have small gains year after year, as they reflect true market growth rates over the entire spectrum of the market.
Picking mutual funds that are advertised as no-load and which don't charge commissions will reduce some of the upfront costs, but management and expense fees will still be charged to the fund annually. To maximize diversity, statistical analysis has shown that a portfolio of 20 stocks from different industries reduces risk as much as is possible. The best mutual funds, therefore, are those that manage about 20 different stocks, with low fees, and growth rates that are relatively slow and predictable over the course of several years.