Mutual funds are one of the most popular ways to invest in the stock and bond markets, especially as part of employer-sponsored 401(k) plans and self-directed IRAs. Mutual funds allow you to buy a diversified collection of assets in just one fund, often at low cost. So you’ll be able to create a diversified portfolio quickly, easily and cheaply.
But with literally thousands of available funds, how do you find the top ones for your portfolio? Bankrate has highlighted some of the best mutual funds based on Morningstar research.
Bankrate selected its top funds based on the following criteria, and included only funds that were investible for regular investors (i.e., not those with $5 million minimum investments):
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Five-star U.S. stock funds according to Morningstar, for quality
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No sales load (i.e., commission), in order to reduce costs
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5-year performance better than the Standard & Poor’s 500, which has historically returned about 10 percent annually on average
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An expense ratio less than 0.5 percent, to minimize ongoing costs
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Funds where the manager has been at the helm for more than five years, to ensure stability
Below are some of the best mutual funds, with performance data as of Feb. 28, 2023.
This fund tries to replicate the performance of the Nasdaq-100 index.
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2023 YTD performance: 10.3 percent
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Historical performance (annual over 5 years): 12.3 percent
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Expense ratio: 0.50 percent
This fund tracks the performance of the Nasdaq-100 index.
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2023 YTD performance: 10.3 percent
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Historical performance (annual over 5 years): 12.2 percent
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Expense ratio: 0.50 percent
This fund looks for high-quality large-cap companies that have sustainable competitive advantages.
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2023 YTD performance: 2.5 percent
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Historical performance (annual over 5 years): 11.9 percent
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Expense ratio: 0.37 percent
This index fund tracks the performance of the Russell Top 200 Growth index, which includes large stocks.
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2023 YTD performance: 7.1 percent
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Historical performance (annual over 5 years): 11.5 percent
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Expense ratio: 0.43 percent
This broadly diversified fund owns high-quality, dividend-paying companies that have a commitment to raising their dividends over the long term.
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2023 YTD performance: -1.8 percent
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Historical performance (annual over 5 years): 11.1 percent
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Expense ratio: 0.27 percent
This fund invests in large publicly traded companies and tracks the total return of the Russell RAFI U.S. Large Company Index.
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2023 YTD performance: 3.1 percent
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Historical performance (annual over 5 years): 10.4 percent
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Expense ratio: 0.25 percent
This fund invests primarily in stocks that pay dividends and have the potential to rise in the future. It invests in both domestic and foreign stocks as well as growth and value stocks.
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2023 YTD performance: 5.1 percent
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Historical performance (annual over 5 years): 9.9 percent
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Expense ratio: 0.49 percent
One of the main benefits of owning mutual funds is the diversification they’re able to offer for relatively low investment amounts and fees. For just an investment of a few thousand dollars, mutual funds can give you a stake in hundreds of companies across different industries, allowing you to build a diversified portfolio.
Ultimately, you’ll make money in mutual funds if the underlying securities in those funds perform well. For stock mutual funds, you’ll need the stocks held in the fund to appreciate in value in order to benefit as a fund investor. You’ll also benefit when those companies pay dividends.
Choosing the best mutual fund for you depends a lot on what you need, in particular your risk tolerance and time horizon. But it also depends on what else you already have in your portfolio. Here are a few key questions to consider in finding the best mutual fund for you:
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When do you plan to access the money? The longer your time horizon, the more risk you can take, meaning stock funds could be the more appropriate investment. If you need the money in the next year or two, you may want to reduce your risk with bond or money market funds.
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Can you withstand temporary losses and hold on? If you can stick with your investing plan for the long term, stock funds will likely be a better investment for you.
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Do you have a specific gap in your portfolio? You may need greater balance in your portfolio. Are you heavily allocated toward bond funds and need some stocks to balance out your returns, or vice versa? Are you invested only in U.S.-based investments and not foreign stocks?
It’s important to know your portfolio and financial situation so that you can assess what mutual fund may be best for you. But even when you find a fund type that you like, you’ll also want to assess which funds are better along a few dimensions.
Ask yourself the following questions:
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What is the fund’s longer-term track record? A higher-performing long-term record (over five or 10 years) is better than a lower one. The fund’s long-term record is your best gauge to how well it may perform in the future.
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Has the fund done well only in the last year or two? A fund that has outperformed only recently may eventually revert to its long-term record. Investors often chase hot performance, then end up buying high and almost inevitably selling low.
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What does the fund charge for investing? Is there a sales load? It’s easy to avoid a sales load, but virtually all mutual funds charge an expense ratio to cover the ongoing costs of the fund and generate a profit.
Some funds (such as index funds) invest in literally the same stocks or bonds as other similar funds. So you can find the same “product” for a lower expense ratio by searching around. For example, any fund based on the Standard & Poor’s 500 index will have substantially the same holdings as another, so the real basis for comparison is the fund’s fees. As the old investor saying goes, “Fees are certain but returns are not.”
Certain investors prefer exchange-traded funds over mutual funds – here’s what to consider.
Mutual funds come in a variety of types and are categorized by the type of investments they own – stock funds, bond funds, money market funds, balanced funds and target date funds.
Stock mutual funds own stocks exclusively, giving them the potential for greater volatility – both higher overall returns and lower overall returns than other types of mutual funds. Included among stock mutual funds are some of the most popular index funds, where the fund is based on the Standard & Poor’s 500 index of top U.S.-based companies. From here they may be further divided into funds focused on growth stocks, value stocks or some combination of the two.
Bond mutual funds own bonds exclusively, making them generally less volatile than stock funds. But they’re also likely to deliver lower returns over time than their stock-based counterparts.
These mutual funds own safe securities such as cash and very short-term debt, making them generally safer than either stock- or bond-based mutual funds but also lower-return. That said, unlike FDIC-backed money market accounts at a bank, money market mutual funds can lose principal, meaning it’s possible, though not likely, that you won’t get your whole investment back.
These mutual funds can invest in stocks, bonds and money market instruments, and generally can offer lower volatility in exchange for lower overall returns. How much is allocated to each type of asset class depends on the fund’s investment manager and its expectations for return.
Target-date mutual funds are popular in 401(k) accounts, and they typically invest in stocks, bonds and money market instruments. Investors pick when they want to access their money (say, at retirement) and then the target date fund selects investments that are appropriate for that time period, reducing risk as the investor nears the target date. Usually this means the fund shifts investments from higher-risk (but high-return) stocks to lower-risk bonds over time.
You may have heard experts refer to active and passive mutual funds.
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Active funds attempt to outperform market benchmarks, such as the S&P 500, by analyzing stocks and trying to pick the ones that will earn the highest returns for the fund. Because these funds have teams of portfolio managers and analysts analyzing investment opportunities, they cost more than passively managed funds.
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Passive funds, on the other hand, do not attempt to outperform a benchmark, but rather aim to equal a benchmark’s performance. These are often called index funds and because no time is spent trying to identify the best stocks to own, the cost to own these funds tends to be significantly lower than an active fund. It should be noted that many active funds not only fail to outperform their benchmarks, but they sometimes generate performance that is below the benchmark. Once costs are added in, investors in active funds are often disappointed.
Yes, you can lose money investing in a mutual fund, but it’s important to remember that a mutual fund isn’t an investment in and of itself, but rather a vehicle for investing in assets such as stocks and bonds. If the assets held in the mutual fund decline in value, the mutual fund’s net asset value (NAV) will also decline. Stocks, bonds and other securities can all lose value and there’s nothing unique about the mutual fund structure that would prevent you from experiencing those losses.
Mutual funds and ETFs both allow investors to purchase diversified baskets of securities at a relatively low cost, but there are some key differences between the two fund-types.
Mutual funds are more likely to be actively managed than ETFs, which is why they come with slightly higher average fees. You could also end up paying a sales commission for some mutual funds. An initial investment of a few thousand dollars is typically required for mutual funds, whereas an ETF can be purchased for the price of one share. Some ETFs allow fractional shares to be purchased, which means you can start investing with just a few dollars.
One of the main differences between mutual funds and ETFs is in the way they’re traded. Mutual funds can only be bought and sold at the end of the day at the fund’s closing NAV, while ETFs trade throughout the day similar to the way stocks trade.
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Diversification. Mutual funds allow you to achieve a diversified portfolio quite easily. For an initial investment of a few thousand dollars you can buy into a fund that contains hundreds of different securities.
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Portfolio management. When you invest in a mutual fund, you won’t have to worry about making changes if one stock does better than another or vice versa. The fund’s portfolio manager handles decisions like that and you can mostly relax.
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Can be low cost. You can get the benefits of mutual fund investing for a low annual fee, but be careful to do your research before deciding to invest. Some funds, such as actively managed funds, could come with an expense ratio of 1 percent or higher, while index funds could cost less than 0.1 percent each year. If cost matters to you, it’s probably better to choose an index fund.
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Reinvestment. Dividends that the fund earns can easily be reinvested into more shares of the fund, allowing your investment to continue to compound over time.
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High initial investment. Compared to ETFs, mutual funds have a high initial investment, typically a few thousand dollars.
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Fees and sales charges. Mutual funds can come with high expense ratios, but you’ll also want to watch out for sales charges that may be included when you purchase or sell a fund.
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Tax events. If you hold mutual fund shares in non-retirement accounts, you may be surprised to get a capital gains distribution from the fund. You have no control over the size of the distribution, so it’s best to own mutual funds in retirement accounts where you won’t have to worry about the taxes.
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Limited trading. Mutual funds are only bought and sold at the end of the trading day once their NAV is calculated.
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ETFs: Exchange traded funds, or ETFs, are very similar to mutual funds, but trade more like stocks. You’ll still be purchasing a fund that holds a basket of securities, allowing you to diversify, but you’ll be able to buy that fund throughout the trading day. Mutual funds can only be bought and sold at their NAV, which is calculated at the end of the day. ETFs are also able to be purchased with smaller investments than mutual funds, which typically require a minimum investment of a few thousand dollars.
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Individual stocks: You could also purchase a basket of individual stocks on your own, but this might require a sizable investment beyond what’s needed to invest in mutual funds. You may be able to build a portfolio using fractional shares, but it could be difficult to match the breadth of the portfolios offered by mutual funds without a meaningful investment. In addition, you’ll need to research each company you’re buying and understand their financial and competitive positioning in order to be successful investing. If you are able to build a portfolio of individual stocks, you’ll also need to monitor it and make sure positions don’t grow or shrink to levels you aren’t comfortable with.
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High-yield savings account: If you’re looking for an alternative to money market mutual funds, a high-yield savings account is likely to be a good option. You’ll typically receive interest beyond what’s available in a traditional checking or savings account and as long as your account is with an FDIC-insured institution, your money will be safe up to $250,000 per depositor, per bank.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
