When Choosing Investment Funds, Look at 3 Factors, Ignore 1

Erin El IssaMar 30, 2021
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This article provides information and education for investors. NerdWallet does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks or securities.

More than half of Americans (53%) say they’re currently invested in exchange-traded funds, mutual funds or index funds, according to a new NerdWallet survey. This same group of respondents shared what factors they consider when choosing investments, and while some are important considerations, others probably shouldn’t be a primary concern.

Here's a look at some practices you may want to adopt in your own investment research, as well as what you might avoid.

What to consider when choosing funds

1. Keep growth in mind, but don’t try to predict the future

According to NerdWallet’s survey, 44% of Americans who are invested in ETFs, index funds or mutual funds say they choose funds based on future growth potential and 32% choose them based on historical growth. You might compare funds' past trajectories, but it's important to understand that past performance isn’t a guarantee of future growth. And rather than try to identify which narrow sector will thrive in the future and invest there, you may want to choose a broad index fund that mirrors the performance of a market index — like the S&P 500 — shown to produce returns over a longer time horizon.

Passively managed index funds and ETFs tend to be low-cost options for those who want a hands-off way to diversify their portfolios.

2. Minimize costs so they don’t eat up returns

The survey shows that close to 3 in 10 Americans who are invested in ETFs, index funds or mutual funds (28%) say they choose funds based on which ones have low fees. Again, passively managed funds tend to carry lower costs, while actively managed mutual funds might be more expensive since a human advisor is choosing the investments.

When evaluating costs, a major factor to consider is the fund's expense ratio. This is an annual fee expressed as a percentage of your investment. You should compare the expense ratio of the fund you’re considering to that of other similar funds to make sure you’re evaluating it in context. While 1% might seem like a low fee, it could cost tens or even hundreds of thousands of dollars more over time than a fund with an expense ratio of 0.25%.

3. Consider social impact if that’s a priority for you

About a quarter of Americans who are invested in ETFs, index funds or mutual funds (24%) say they choose funds comprising companies or industries that align with their beliefs, according to the survey. Socially responsible investing, or SRI, is gaining in popularity and allows investors to choose funds composed of companies doing good in the world, such as promoting racial equality or having sustainable practices.

“Doing good” means different things to different people, but you can start by screening for funds based on factors that matter to you. Remember to check out expense ratios for any SRI funds you’re interested in, as you may find that some have higher fees than traditional funds.

What not to consider when choosing funds

Word of mouth

According to the survey, among Americans who are invested in ETFs, index funds or mutual funds, 19% say they choose funds recommended by loved ones and 13% say they choose funds discussed in the media. Even if your loved one is a financial professional or otherwise financially savvy, it may not be a great idea to get investing information from friends and family.

Instead, do your own research. Likewise, investments discussed in the media might not be the best suited to your needs. And consider your personal financial goals, risk tolerance and the amount of time you have to invest when choosing your investments.