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Mutual Funds

20,000.

That's the approximate number of open-ended mutual funds in existence as of mid-2006. Choosing between them all is the challenge for most investors.

We thought it might be helpful to consider the following when thinking about mutual fund investments:

Managed vs. Index. We take a neutral position on this argument, but we pose the question: is settling for average what lights your fire? (If you don't get the question, discuss it with your financial consultant the next time you talk).

Manager. Longevity is good when the manager is providing above par performance. Remember, however, that even the brightest and best can lose their way over time. One useful measure is "alpha", which is the value that the manager adds. Higher alpha is obviously better.

Performance. You must always ask exactly how did the manager achieve that performance and is it sustainable.

Expenses. Certainly low is better than high in this context, but wouldn't it be foolish to buy an underperforming fund with annual expenses of 0.5% versus a reliable out-performer with an expense ratio of 1%?

Fund type. Investors should be concerned about "style drift"; that is, when a manager with excellent performance "drifts" away from the style that has served him/her well. Be sure that the fund you are considering sticks with its normal strategy.

Risk. Assessing the risk of a particular fund is not easy and involves looking at several factors. Here's one of the most important: concentration. As much as this can be a "plus" in bull market, it can be a devastating "minus" when things get rough. For sure, check the exposure of your fund to a single industry, or, even more important, a single stock.

There are other important considerations (such as tax efficiency, reputation of the fund family etc.), but perhaps the real key - forgotten by all too many investors - is to monitor your fund frequently. You should not be quick to exit a fund that appears to be slipping, but attempt to understand if the slippage is structural or merely temporary.