10 Best Mutual Funds

To identify the 10 best mutual funds, we screened the roughly 10,000 funds available for those in the top 33.2% of returns over a mix of three, five and 10 years. We also screened for the bottom 10% of expense ratios. And we discarded any whose minimum initial investment exceeds $3,000.

We then eliminated sector funds as well as narrowly focused mutual funds that concentrate on a specific geographical region or industry group. Money market funds were also excluded. In addition, we excluded alternative, commodity and stock-plus-bond funds. Those steps winnowed our list down to 176 funds.

After identifying each fund’s Morningstar category, we selected a mix of active and passively managed funds.

Our final list included those funds that beat competitor category returns over 10 years, as well as some funds that also outperformed their index returns. For the one fund that is not 10 years old, we insisted on outperformance versus its category average since inception.

Our best equity list spanned value, growth and blend investment styles. We also chose market-capitalization and fundamental strategies. We included representation from large-, mid- and small-cap firms as well. A sustainable equity fund was selected for socially responsible investors. The bond categories included municipal bonds, for those in higher tax brackets, as well as long and intermediate term fixed income funds.

A mutual fund pools money from many participants to buy a portfolio of stocks, bonds and other securities. The fund sells shares to investors, with each share representing an equity ownership stake in the mutual fund and the income it generates.

Mutual funds offer investors an excellent source of diversification for their portfolios. These funds typically own hundreds or even thousands of different securities.

The securities a mutual fund buys depends on the fund’s investment objectives. For example, a growth fund will target stocks with above-average growth potential, while an income fund may include both dividend-paying stocks and bonds.

Each share of a mutual fund represents a prorated amount of all the investments within the fund. If 10% of a mutual fund’s portfolio is in shares of Tesla, 5% Comcast (CMCSA) and 2% The Cheesecake Factory (CAKE), each fund investor reaps the appreciation, or loss, for these holdings in equal proportions.

It’s important to remember that you don’t own the underlying securities held by a mutual fund. Instead, you own a share of the fund itself. In the above example, you wouldn’t own the shares of Tesla, Comcast and The Cheesecake Factory; you would own shares of the mutual fund which in turn owns these companies.

Investors receive the profits and income generated by the mutual fund’s holdings through distributions. They can choose to take the distributions as cash or reinvest them in the fund.

Shares of mutual funds trade on stock exchanges like stocks, but they operate a little differently. They trade only once a day, at the market close. They’re not exchanged between investors; instead, you buy and sell them directly with the fund manager.

At the end of each trading day, the fund manager calculates the net asset value, or NAV, of the securities in the fund, then sells or redeems fund shares at this price. For investors, this means that you won’t know the price you’ll pay or receive until after the market closes.

Mutual fund managers pass on the costs of operating the fund to investors via various fees and expenses.

Funds may charge a variety of different fees, so you need to be aware of the different ways you can be charged. You can see what fees a given mutual fund charges in the fund’s prospectus under the “Shareholder Fees” section. Fees may include:

• Expense ratio. The most common fee, this represents the percentage of the money you invest in the fund that will go to covering the fund’s cost, rather than generating a return on your investment. Almost all mutual funds will have an expense ratio, and the cost will be higher for funds with active management than passive management.
• Sales load. A sales commission paid to brokers for selling you shares of the fund. These can be charged when you purchase shares—“front-end sales loads”—or when you sell your shares—“back-end sales loads.” Look for “no-load mutual funds” to avoid paying these fees.
• 12b-1 fees. Fees deducted from fund assets to pay for marketing and distribution expenses incurred by the fund.
• Redemption fees. This fee is deducted from your proceeds when you sell shares of the mutual fund.
• Exchange fees. Charged if you exchange shares of one mutual fund for another fund in the same group.
• Purchase fees. A fee charged when you purchase shares of a mutual fund.

You always want to minimize the fees you pay, since they eat into returns. Even seemingly small fees can lead to big changes in long-term returns, thanks to compounding. For example, a mere 1% increase in fees on a $10,000 investment that earns 10% per year can cost you more than $10,000 over 20 years.

You will likely pay taxes on mutual fund distributions if you own funds in a taxable brokerage account. If you sell shares at a profit, you’ll need to report the transaction on your tax return. This is true even if you only move money between mutual funds without taking any out as cash.

Most mutual funds pay distributions at the end of the year. You’ll receive an IRS Form 1099-DIV each year detailing the distributions that were paid to you in that calendar year.

How much you pay in taxes will depend on the type of distribution. For example, proceeds from selling a mutual fund you held for more than one year are typically taxed at more favorable capital gains tax rates while short-term capital gains from funds you held for one year or less are taxed as ordinary income.

The exception to the tax rules are qualified accounts like individual retirement accounts, which are only taxed when you withdraw funds from the account.

Mutual funds can be classified based on the types of investments they hold:

• Stock mutual funds. Also called equity funds, this type of mutual fund owns shares of stock in public companies. Equity fund investors generally want more appreciation than income payments—or yield—although there are specialized dividend funds that aim to generate yield.
• Bond mutual funds. Also referred to as fixed-income funds, this kind of mutual fund owns Treasurys, municipal bonds or corporate bonds. Bond fund investors tend to want income preservation and yield.
• Balanced funds. Also called blended funds, these mutual funds invest in a portfolio of both stocks and bonds.
• Money market mutual funds. These mutual funds tend to offer very low yields and very low risk compared with bond and equity funds. Instead of appreciation or yield, money market fund investors are looking to preserve the value of their cash above all else.
• Target date funds. These funds are designed for retirement investors and generally have a “target date” year when holders are expected to retire. They hold a mix of stocks, bonds and other securities. Over time, the portfolio shifts its allocation from riskier investments to safer investments.

You can invest in mutual funds through an online broker just as you would stocks, but most people buy mutual funds in their 401(k) account or IRA.

When investing in mutual funds, keep your investment goals in mind as this will dictate the type of mutual fund you may want to use. For example, long-term goals that are decades in the future may be best served by stock mutual funds with more growth potential while shorter-term goals in the next few years may require the relative stability of a bond fund.

Also keep an eye on fees. Remember that fees reduce overall returns. The industry average expense ratio is 0.57%, but many funds charge much less. There are even zero expense ratio funds, such as Fidelity Investment’s Zero Funds.

Mutual funds offer an attractive combination of features that make them a good option for many individual investors. These include:

• Diversification. The shortest definition of diversification is simply “never put all your eggs in one basket.” Mutual funds embody this approach as they own a portfolio of securities that includes a very broad range of companies and industries. This helps to lower risk and potentially boost returns.
• Affordability. Mutual funds typically have low minimum investment requirements and charge reasonable annual fees.
• Professional management. Not everyone has the time and knowledge to manage a diversified investment portfolio. When you buy shares of a mutual fund, the fees pay professional managers to choose the securities owned by the fund and manage the assets through good markets and bad.
• Liquidity. When you own shares of a mutual fund, you can easily redeem them at any time. The fund will always buy back your shares for an amount equal to the current NAV plus any redemption fees.

When you invest in a mutual fund, you get instant diversification as every dollar is invested in the underlying securities at the same proportion as the overall fund. So even if you put $1 in a fund with 100 securities, your $1 will be spread across all 100 securities. Similarly, your $1 will benefit from the same professional management as an investor with $100,000 in the fund.

There are thousands of mutual funds available on the market today. That means you need a good understanding of your financial goals to choose the right mutual fund for your needs.

Are you investing for retirement in your 401(k) account? Which is more important, long-term capital gains or recurring income today? Answering questions like these about your financial goals are essential before you begin diving into the world of the best mutual funds.

After you’ve determined clear goals, you should also understand your risk tolerance. Are you willing to see big swings in the value of your mutual fund over the short term in exchange for better gains over the longer term? Would you be more comfortable with a steady, gradual rate of appreciation plus reliable income payments?

You may already understand that risk and return are directly proportional. That makes it essential to calibrate the rate of return you expect against the amount of volatility you can accept in your mutual fund investments.

Once you’ve settled on a level of risk that’s right for you, you’ll need to start digging into mutual fund lists like this one and start researching individual funds. Learning about how each fund works helps you know if it’s right for your goals and risk tolerance.

Learn about each fund’s management team. Do they have a history of success? For active funds like we have listed above, it’s important to read the managers’ track record.

Does a fund have a high or low turnover rate in its investments? When fund managers buy and sell frequently, it creates taxable events. That’s nothing to worry about if you own shares of a mutual fund in a tax-advantaged retirement account, but if you own shares in your taxable brokerage account, that could greatly diminish your long-term gains.

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