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Researching Funds on Morningstar

While I’m a big fan of Vanguard funds, there are plenty of reasons why investors might want (or need) to use funds from a different company — the most common reason being that many investors don’t have the choice of Vanguard funds in their 401(k).

So what do I do when somebody asks me for an opinion regarding a fund I’m not particularly familiar with? I turn to Morningstar.

Things to Check for Every Fund

When researching a fund, the first thing I check is the fund’s expense ratio. As a rule of thumb, unless there’s no way around it (e.g., in an employer-sponsored plan with no low-cost funds), I rule out any fund with an expense ratio greater than 0.30%. If you have your choice among funds (in an IRA, for instance), there are several options in each asset class with costs below that point.

Next, I click over to the “portfolio” tab on Morningstar to check out the fund’s overall asset allocation. How much does the fund have in:

  • U.S. stocks,
  • International stocks,
  • Bonds, and
  • Cash?

This question is important because you cannot implement an asset allocation plan without first knowing the underlying asset allocation of the funds you’re using.

You’ll want to pay particular attention to the amount of cash that stock and bond funds hold. In general, the less cash a fund holds the better. Cash is a perfectly reasonable thing to hold in a portfolio, but there’s generally little benefit to paying a fund manager to hold it for you.

Researching Stock Funds

The next thing I do (still on the “portfolio” tab) when researching a stock fund is check out the tic-tac-toe-looking “holdings style” breakdown. This is important because you can’t always tell from the name of a fund whether it’s more heavily weighted toward value stocks or growth stocks. In fact, even if the fund has “value” or “growth” in the name, that doesn’t necessarily mean much. Better to actually check the numbers.

As an example, here’s the information for Fidelity’s Spartan Total Market Index Fund:

This tells us that the fund is very evenly split between value and growth stocks and that it’s primarily a large-cap fund, with modest mid-cap and small-cap holdings. In other words, it’s exactly what you’d expect from a “total market” stock index fund.

If I’m researching an international fund, the next thing I check is the breakdown between developed and emerging markets (at the very bottom of the “portfolio” page). There’s no right or wrong answer here, but it’s important to check so that you know what level of risk to expect from the fund. (The larger the allocation to emerging markets, the greater the risk.)

Finally, I take a quick glance at the “Sector Weightings” of the fund. I do this simply to make sure that it’s not super-heavily weighted in just one or two sectors (e.g., healthcare), because you can’t always tell from the name.

Researching Bond Funds

When researching a bond fund, after checking out the expense ratio and asset allocation, I check two things (again, both on the “portfolio” tab) to get an idea of the risk-level of the fund:

  • The average duration, and
  • The credit quality breakdown.

As we’ve discussed before, the duration of a bond fund is an important indicator of its risk level because the longer the duration, the more the fund’s price will fluctuate as a result of changes in market interest rates.

Credit quality is important for obvious reasons. Personally, I prefer to look at the actual breakdown (how much in AAA, how much in AA, etc.) rather than just looking at the average credit rating because averages can be deceiving.

Other Points of Note

If the fund in question is going to be held in a taxable account, I make sure to look at two additional metrics: the “tax cost ratio” (on the “tax” tab) and portfolio turnover (on the “quote” tab), both of which can give an idea of the fund’s tax efficiency. (In both cases, a lower figure suggests better tax efficiency.)

Finally, you may have noticed that I didn’t mention checking performance at all. That’s because I often don’t. Past performance really is a poor indicator of future results. If I check a fund’s performance at all, it’s usually just to visually compare it to the performance of another fund to get an idea of the funds’ similarity to each other.

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  1. I just discussed this topic over on the bogleheads forum… they said to decide your asset allocation first, then to choose the lowest cost funds available in your 401K to accomplish that goal, even if the only fund that will cover a particular sector of your asset allocation is more expensive (for example my international funds are all over .5 MER – but they said not to skip this category just because it was more expensive than I would like). Is this also your position?

  2. Tara,

    My position would be as follows (and I imagine it’s in keeping with what most Bogleheads would say).

    1) Choose your desired asset allocation, then
    2) Implement that allocation in the lowest-cost way possible.

    Sometimes that does mean using funds that are more expensive than you’d like, because you have no alternative.

    In some cases, however, it’s possible to configure things so that you’re able to use one or two low-cost funds in your 401(k), then pick up the other necessary pieces of the allocation via an IRA.

    (This post explains the process in a bit more detail.)

  3. why do you think VTINX has something like 5% in cash?

  4. Nancy,

    In general, I think it’s preferable for investors who want to hold cash to hold it outside of their funds, because it’s easy (and less costly) to do so.

    But my guess is that because Vanguard wants their target retirement funds to be all-in-one solutions, and because they think retired investors should have a conservative allocation that includes cash, they bundle the cash into the fund rather than leaving investors to supplement the fund with their own cash holding.

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