Decades ago, there was a shift away from pension plans to workplace and individual retirement plans like 401(k)s and IRAs. In the days of workplace pensions, an investment committee managed all aspects of a portfolio for a company’s employees. But today, more people find themselves in the driver’s seat in deciding how to invest their own retirement dollars.

In addition, with social media and financial media today, consumers are bombarded with investment advice and opportunities. As an investor, it’s difficult to know where to turn and whose advice to trust with your hard-earned money.

Having an approach that filters through this noise is a necessity. To help you understand which financial advice to listen to and which to throw to the wayside, we’ve compiled a list of 10 “rules” of fund selection (i.e., picking what mutual funds and ETFs to invest in) to help you build an investment portfolio designed with your goals in mind.

Before We Begin: Start with Your Portfolio Strategy

Before you can implement the key rules for fund selection, you have to start at square one. And in this case, that means having a portfolio that aligns with your future aspirations and liabilities. By knowing your financial goals, time horizon, and risk tolerance, you can determine your North Star for your target asset mix between stocks, bonds, and alternative investments. 

Once you’ve identified your portfolio strategy, you can put guardrails in place around your asset allocation and rebalancing strategy. Without having some portfolio guidelines in place, you’ll be missing an important piece of the puzzle of building an investment portfolio to help you reach your goals. 

10 Rules for Fund Selection

Rule 1: Evaluate Risk-Adjusted Performance

A fund’s returns are important, but they’re not the only factor to consider. Instead, it’s important to make sure the returns are adequate relative to the amount of risk. A fund with relatively low volatility but steady returns may be more suitable than one with occasionally higher returns but high volatility. Compare funds against the right benchmarks to make sure the risk is worth the reward.

Rule 2: Know the Downside Case

Every investment comes with risks, and they’re just as important as the potential gains. If we understand the risks, in addition to what can go right, then we can be more confident that there’s a margin of safety. Ask yourself: what’s the possible downside case here?

Rule 3: Look for Consistent Outperformance

You don't want any one-hit wonders in your portfolio, where performance is driven by a single stock, sector, or short-term trend. Instead, the goal is to invest in funds that have solid overall performance across different periods and conditions. For example, a fund that beat its benchmark steadily over five years is a better option than one with better performance in a single year but lackluster results the other four.

Rule 4: Favor Team-Based Management Over Star Managers

Every investment fund has at least one manager who is responsible for choosing what assets make up the fund and carrying out its strategy. However, many funds take a multi-manager approach, which offers some benefits.

Look for funds that rely on a systems approach rather than having one star player who, when they leave, the fund’s performance may suffer. As an investor, you should never notice a difference in your investment performance based on one manager. Instead, opt for those that use team-based management.

Rule 5: Account for Taxes

Your net post-fee and post-tax return is the most important number. It doesn’t matter how high your returns are if you’re losing a significant chunk of them to taxes. In fact, it could even be the case that the lower-earning fund turns out to provide higher after-tax returns.

When you’re choosing funds, consider exchange-traded funds (ETFs). You’ll be able to lower your tax burden, and you may be able to do it without negatively impacting your investment performance.

Rule 6: Ensure Alignment of Incentives

Incentive alignment means that what’s in the best interests of the investor is also what’s in the best interests of the fund manager. It provides confidence when fund managers have skin in the game. Additionally, consider looking for those funds that reward managers for long-term performance rather than short-term wins. That way, you’ll know they have the same end goal as you.

Rule 7: Conduct Operational Due Diligence

A fund may have solid returns over a short term, but if it doesn’t have the right operations in place, its success may only be temporary. Look for funds that have a proven track record and use only established service providers.

Rule 8: Assess Fund Size Appropriateness

There’s a sweet spot when it comes to fund size. Too much capital can overwhelm an asset class or a manager’s strategy, causing dilution. On the other hand, too little capital can be a detriment to scale and result in higher costs. There should be cohesiveness between the fund’s size and its stated investment approach.

Rule 9: Evaluate Today’s Opportunity Set

Past performance isn’t necessarily indicative of future results. Instead of looking solely at a fund’s historical returns, analyze how today’s prices and market compare to the past to ensure its approach makes sense for the current market conditions.

Rule 10: Make Sure Fees Are Fair

Fees are a normal part of investing, but they reduce the portion of your investment returns you get to keep and can eat away at your earnings over time. Compare a fund’s fees to industry benchmarks to make sure they aren’t unreasonably high. If you invest in a fund with higher fees, make sure those fees are justified by a better fund strategy or better performance. 

The Filtering Process: Why Most Pitches Get a “No”

As an investor in today’s media-first world, you’re likely hit with a constant stream of investment pitches and ideas. But when you hold each pitch to these 10 rules, you’ll find most are easier to decline. Discipline and repetition can help sharpen your fund evaluation and will become your guideposts in building your investment portfolio.

Conclusion

When it comes to fund selection, process should beat out hype every time. By applying these 10 rules, investors can filter out the noise, align investments with long-term goals, and avoid costly mistakes.

The good news is, you don’t have to navigate this process alone. If you’d like guidance in applying these principles to your own portfolio, consult with a trusted financial advisor who can build a disciplined investment strategy.

FAQs

What should I look for when selecting a fund?

When selecting a fund, it’s important to look for risk-adjusted performance, consistent long-term results, fair fees, strong management, and alignment with your portfolio goals.

What is risk-adjusted performance in investing?

Risk-adjusted performance is a measure of how much return a fund generates relative to the risk taken. It’s a metric that can help investors compare funds more accurately. When comparing two funds, one with similar returns but lower risk is likely preferable to a fund with the same returns but higher risk.

How do fees impact fund performance?

Every dollar you pay in investment fees is a dollar that you’re not reinvesting. Even more important than their immediate impact, high fees eat into your long-term returns. Even a 1% annual fee difference can significantly reduce your portfolio’s value over decades.

Why does fund size matter?

Fund size matters because it can impact potential returns, diversification, adaptability, fees, and more. Too much capital in a fund can dilute opportunities, while too little capital can limit scale and increase costs for investors. Both of these can hurt performance. 

What’s the most important rule in fund selection?

There’s not necessarily one rule in fund selection that’s more important than the rest. Instead, using all of these rules together and aligning your fund choices with your portfolio strategy will give you the best results.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. 

There is no guarantee that asset allocation or diversification will enhance overall returns, outperform a non-diversified portfolio, nor ensure a profit or protect against a loss. Investing involves risk, including possible loss of principal.

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