The best American Mutual Funds of 2007

Picking the best mutual fund for 2007 is simple, but you will have to wait until the end of the year to do it. Without the benefit of hindsight, the best you can do is to make an educated guess. The performance of any given mutual fund will depend on an infinite number of variables, not the least mercurial of which is the market itself.

Market prognosticators are a dime a dozen and, if anyone could truly predict the future path of financial markets, that knowledge itself would impact the market (with apologies to Warren Buffet). Your hairdresser can give you some hot stock and mutual fund tips and be right 50% of the time. Unless you have an adrenaline deficiency or a substantial trust fund, you need to do your homework. If you aren’t willing to do your homework, then you should bet on the market in general and buy a stock index fund. Index funds track the up and downs of the market and can be based on a number of U.S.- based stock indices such as the American Stock Exchange, the Russell 3000, or Standard and Poor’s 500. If you are still determined to beat the market by investing in mutual funds, I would consider:

Economic Fundamentals. You don’t need to know how the sale of a latte at Starbucks will affect the demand for new houses in Timbuktu, but you need to understand the basics. The value of a dollar, interest rates, unemployment, the trade deficit and a host of other market indicators may forebode feast or famine for a given fund.

Your Timeline. How soon will you need the money? Is this a short-term investment to buy a house in a few years? Or can the money be put to work for a couple of decades, until retirement? Typically, you can afford more risk in longer-term investments.

Your Risk Tolerance. The inverse relationship between risk and reward can be understood by a first-grader but is still too often ignored by investors. Slick web pages and glossy brochures produced by the mutual fund companies, although they will all carry the standard disclaimers, may lead you to discount the risks associated with buying a given fund. Look at the fund’s beta index which measures the funds volatility against the S&P 500.

The Fund’s Portfolio. Funds that don’t concentrate in a sector (ie: real estate, or medical stocks) usually concentrate their investments in either small firms (small- caps), mid-size firms (mid-caps) or real leviatians (large caps). Also, they can hold some investments in bonds and some in cash. The proportions that can be held in each type of investment will often be prescribed by the funds prospectus.

The Fund’s Diversification. Don’t just look at a list of stocks owned by the fund, look at the percentages it owns. Hypothetically, a fund may have 50 stocks, but 60% of its money in one stock.

The Fund’s Fees. There are operating fees (which can differ considerably from fund to fund), marketing fees (12b-1), front-end loads, back-end loads, broker’s commissions, etc. Know what they all are and how they affect the fund’s performance.

The Number of Stocks the Fund Owns. A fund which only holds 20 stocks will inherently be riskier (or more lucrative depending on your view) than a fund which holds 100.

The Fund’s History. All fund disclosures statements will tell you “that past performance is no guarantee of future performance”. But, as Dr. Phil will tell you, “the best predictor of future behavior is past behavior”. Despite my general distaste for Dr. Phil, he makes a good point here. Just make sure that you have a lot of past behavior to look at. Unless you are an experienced investor, it is probably best to stick with funds that have 10 years or more to compare. It is also important to know how the fund has performed historically in both bear (down) and bull (up) markets.

The Fund’s Size. Usually when a fund outshines it competitors, over time more investors are attracted to it. As a fund grows, its ability to deftly move in and out of stocks may be impaired. Occasionally, a fund will close itself to new investors for this reason.

The Fund’s Rating. You don’t need to reinvent the wheel. Other companies have been tracking and comparing mutual funds for years and you can benefit from their research. Morningstar Mutual Funds ( has been categorizing, analyzing, and comparing funds since the 1980’s and is an invaluable source of information.

I recommend “The little book of Common Sense Investing” by John Bogle for well-written and easily understood tips for newbies. Also, any of the books written by the “Motley Fools”, whose style is irreverent but advice is anything but foolish. Moreover, read anything written by Benjamin Graham, Warren Buffet, or Peter Lynch if you want to understand some of the country’s greatest financial minds.

Warmest Regards