The best mutual funds will help you build wealth over years — and can help secure your financial future.

If you like the idea of convenience, low cost, and professional assistance in your financial life, you should be quite interested in mutual funds. Don’t just buy any old funds, though, and don’t think it’s enough to just look for funds that did really well last year.

Mutual funds can save you from spending lots of time and energy studying many companies and managing investments in various stocks, but you do still need to spend a little time making sure you’re investing in good mutual funds.

Here’s how to zero in on good mutual funds, along with a list of some of the best for your money in the coming year.

Active funds vs. passive funds

A key mutual fund distinction to understand is that there are active funds and passive funds — that is, funds that are actively or passively managed. You probably imagine a mutual fund as one where lots of shareholders have pooled their money, which is managed by a team of financial professionals who scour the universe of investments and choose which ones the fund will buy and sell, and when. That’s an actively managed fund.

A passively managed one, on the other hand, requires far less brain power to run. Index funds are classic passive funds, and each one is designed to track the performance of a certain index (like, say, the S&P 500 index of 500 of America’s largest companies) by investing in roughly the same securities in roughly the same proportion.

There are close to 8,000 different mutual funds, as of 2018, plus nearly 2,000 exchange-traded funds (ETFs) — which are similar structures — according to the Investment Company Institute. The vast majority of the ETFs are index funds, while index mutual funds have grabbed 29% of the assets of all mutual funds, as of the end of the year.

What’s best for you?

If you want your portfolio to grow at an above-average rate, you’ll probably need to learn enough to select stocks that will grow at an above-average rate — and that’s far easier said than done. So you might instead opt for mutual funds that aim for above-average returns — but that might be even harder to do, because the vast majority of managed stock funds fail to do as well as their benchmark indexes. Indeed, as of the middle of 2019, fully 88% of all domestic stock mutual funds underperformed the S&P 1500 Composite index over the past 15 years, while a whopping 90% of large-cap stock funds underperformed the S&P 500.

Clearly, opting to just stick with low-fee index funds is extremely reasonable, and will likely have your portfolio outperforming most managed funds. But it is possible to find some great managed funds that will outperform, if you’re willing to take the chance and you want to put in the effort. Below are promising characteristics of funds, along with some promising fund ideas for further research. You’ll find some top index funds listed, as well.

The marks of the best mutual funds

A key factor when assessing any mutual fund is its fees. The median annual fee (“expense ratio”) for stock mutual funds was recently 1.16%, per the Investment Company Institute, with plenty of them charging more than 2%. Meanwhile, the subset of stock index funds sported a median of 0.33%. That alone goes a long way toward explaining why index funds outperform. Imagine you invest $5,000 annually in each of two funds for 25 years. If your average return net of fees is 10% in one fund but it’s only 9% in the other, you’ll end up with $541,000 in the former fund and only $462,000 in the latter — a difference of roughly $79,000.

Next, it’s natural to assess a mutual fund’s track record, and to favor those with strong average growth rates. Tread carefully there, though, and look at each year’s return, because one unusually strong (or weak) year can give a fund a somewhat misleadingly positive (or negative) average. Avoid rushing your dollars into any fund that was a top performer in the past year, too, because that reflects just a thin slice of time.

It’s well worth looking into the managers of any managed mutual fund you’re considering. See if you can dig up some interviews with them, some annual letters to shareholders, and any coverage of them in the news. Ideally, they will impress you with their candor and you’ll like their investing philosophy and approach.

Finally, look at a fund’s turnover ratio, which reflects how often its managers buy and sell securities. Specifically, a turnover ratio compares the total value of securities bought and sold in a period (such as a year or quarter) with the total value of all assets in the fund. So a turnover ratio of 100% reflects a lot of activity — as if the managers sold and replaced all their holdings. What’s wrong with that? Well, several things. For starters, it doesn’t suggest that the managers had a lot of confidence in what they bought, if they’re quickly selling. Also, all that activity can generate trading costs that are passed on to shareholders, and any gains will be fairly likely to be short-term ones, which are generally taxed at a higher rate.

Some of the best actively managed mutual funds — for 2020 and beyond
Below is a variety of well-regarded, well-performing fund candidates to consider, for any money that you choose to not park in low-fee, broad-market index funds. They’re all “no-load,” meaning that they don’t levy an up-front sales charge when you buy into them, as many other funds do.

Wasatch Micro Cap (NASDAQMUTFUND:WMICX)

Small-cap stocks

1.65%

Fidelity Low-Priced Stock (NASDAQMUTFUND:FLPSX)

Mid-cap stocks

0.52%

Dodge & Cox Stock (NASDAQMUTFUND:DODGX)

Large-cap value stocks

0.52%

Primecap Odyssey Stock (NASDAQMUTFUND:POSKX)

Large-cap stocks

0.66%

T. Rowe Price Blue Chip Growth (NASDAQMUTFUND:TRBCX)

Large-cap growth stocks

0.70%

T. Rowe Price Communications & Technology (NASDAQMUTFUND:PRMTX)

Large-cap stocks

0.78%

Vanguard Health Care Investor (NASDAQMUTFUND:VGHCX)

Large-cap stocks

0.34%

Dodge & Cox Income (NASDAQMUTFUND:DODIX)

Large-cap dividend stocks

0.42%

Vanguard Dividend Appreciation ETF (NYSEMKT:VIG)

Large-cap dividend stocks

0.06%

Matthews Pacific Tiger Investor (NASDAQMUTFUND:MAPTX)

Large-cap international stocks

1.04%

Buffalo International (NASDAQMUTFUND:BUFIX)

Large-cap international stocks

1.06%

Fidelity Total Bond Fund (NASDAQMUTFUND:FTBFX)

Intermediate-term bonds

0.45%

DATA SOURCE: MORNINGSTAR.COM.

Some of the best index funds — for 2020 and beyond
For many, if not most, people, index funds are best. Many sport ultra-low fees, which lets you keep most of any gains, and their turnover rates are low, too, as each fund only has to buy and hold the same securities as the index it’s tracking. Below are a handful of the many top-notch ones out there. (They’re in exchange-traded fund (ETF) form, which means you can buy or sell as little as a single share at any time through the stock market.)

SPDR S&P 500 ETF (NYSEMKT:SPY)

S&P 500

0.09%

Vanguard Total Stock Market ETF (NYSEMKT:VTI)

Total U.S. market

0.03%

Vanguard Total World Stock ETF (NYSEMKT:VT)

Total world market

0.09%

Schwab U.S. Mid-Cap ETF (NYSEMKT:SCHM)

Mid-cap stocks

0.04%

iShares Core S&P Small-Cap ETF (NYSEMKT:IJR)

Small-cap stocks

0.07%

Vanguard Real Estate ETF (NYSEMKT:VNQ)

Real estate investment trusts

0.12%

Vanguard Intermediate-Term Bond ETF (NYSEMKT:BIV)

Intermediate-term bonds

0.07%

Schwab U.S. Aggregate Bond ETF (NYSEMKT:SCHZ)

Total bond market

0.04%

DATA SOURCE: MORNINGSTAR.COM.

It’s hard to beat mutual funds for convenience, and the best ones will have your money growing powerfully over many years. Take some time to learn more about mutual funds, so that you can make smart, informed decisions regarding them.

Author: Selena Maranjian

Source: Fool: The Best Mutual Funds to Buy in 2020

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