The Proper Investments For Your Retirement Money

Let's say you already are accumulating or have now decided to accumulate wealth in one or more of the retirement plans or IRAs we have just discussed.  Typically, you will be able to direct that wealth into a variety of investment options.  Which one is best?

Risk/Return

Recall my beginning comments in this section of the book relative to compounding interest and the effect of investment yield over time.  As I noted there, an investment yielding 6% over 36 years would double three times, whereas an investment yielding 12% would double six times.

Obviously, all things being equal, we would pick an investment with a higher yield, as it will accumulate significantly more wealth over time.  But here is the rub: generally speaking, the higher the investment yield, the more risky that investment is.  The classic comparison is between stocks and bonds.

Stocks

Although small businesses take many different legal forms (proprietorships, partnerships, S corporations and limited liability companies), virtually all companies that are traded on a public market are regular corporations.  Ownership in any corporation is evidenced by stock, typically voting common stock.  Such a stock interest gives the stockholder a proportionate interest in the underlying equity and wealth of the corporation as well as a proportionate voting right.  Thus, as the underlying value of the corporation goes up or down, so does the market value of a share of stock in that corporation.

Bonds

Bonds are debt instruments.  When you buy a bond, you are lending money to the company or governmental entity that is issuing the bond.  The bond will typically pay a fixed rate of interest over a stated term, with the face amount of the bond usually repaid at maturity.  For example, when I buy a $1,000 bond paying 7% interest that matures in 10 years, I lend the bond issuer the $1,000 and I am paid $70 of interest each year until maturity of the bond 10 years down the road, at which point I am repaid my $1,000.  All things being equal, less creditworthy companies may have to pay a higher rate of interest than more creditworthy companies in order to sell their bonds.

Bonds have a relatively low and stable yield whereas stocks historically generate a much higher yield.  Bonds (at least government bonds) are considered one of the safest forms of investment whereas an investor in the stock market may not see a high return at all and, in fact, could lose his or her investment in those stocks.

I am generally very bullish (optimistic, aggressive) about the American stock market.  Why?  Because I am very bullish on the American economy.  Despite occasional dips and blips on the radar screen caused by political or world events, America is far and away driving the rapidly expanding world economy.  We are experiencing a new economic revolution (far more powerful than the 19th century Industrial Revolution that we learned about as kids) and American companies are leading the way.  Barring the long-term success of terrorism or another worldwide catastrophe, this phenomenon will not stop or slow down for long.

It is hard to fully accept this proposition in hard stock market times – like the early 2000s.  But step back and focus on an historic example that will surely repeat itself in the near future. Think about what happened a few years ago with the Asian stock markets.  Those markets, for a variety of reasons largely unique to them, took a significant hit.  Our American stock markets also dipped in response.  But then what happened?  While the rest of the world's markets stagnated, ours increased, quickly making up for the temporary dip.

Why did this happen?  For the reasons I mentioned above and also for a very significant additional reason - America is the safest place in the world to invest.  In historic times, investing in gold was a safe haven in bad times.  A more modern analogy is investing in the American dollar and American companies in bad times.  There is a tremendous amount of wealth in the world besides in the United States.  When things get bad elsewhere, that wealth floods into our markets, increasing the number of buyers.  Under a simple supply and demand analysis, the more buyers chasing the same amount of goods or services will invariably drive the price up and this is exactly what happened to the American stock markets in response to the Asian market downturn.

Apart from pointing out another way that we are blessed as Americans, what is my point here?  Don't be afraid to invest in the American stock markets if you have a significant period of time before you retire.  Any stock market ebbs and flows.  However, the important fact is whether it is trending upward over time.  If it is (as our American stock market significantly has), the more time we have to work with the better assurance we will have that our returns over time will be meaningful.

What is my opinion on all of this?  If you have 20 or more years before you retire, you should be entirely or substantially invested in the stock market.

Dollar-Cost Averaging

If you are a younger person and do take my advice about investing in the American stock market, here is a simple way to make it work in a big way: "dollar-cost average" the investment in your retirement plan.  Dollar-cost averaging is simply plopping in the same number of dollars on a regular basis (preferably monthly).  If you follow this strategy and invest mostly or entirely in stock funds, you must decide beforehand that when the stock market does go down, you will continue to fund your stock account via this dollar-cost averaging method.  This may strike you as throwing good money after bad but it absolutely is not.  Here is why.  We will note momentarily that stock funds over time have done very well.  Nonetheless, there have been distinct dips in the historic record on stocks.  If you are just buying into a stock fund when it is doing well, you are paying the top dollar price for your investment in that stock fund.  The key is to also make some bargain purchases when the stock fund has declined.  In this way, you are buying at the highs and lows and getting an excellent average rate of return over the long-term.

Take a look at the following EXHIBIT that dramatically demonstrates the wisdom of continuing to invest in bad stock markets as well as good ones.

Market Recovery Periods Since October 1987

S&P 500 Index

Transition of Investment Strategy

As discussed above, it is common and accepted wisdom that the longer your investment horizon (the longer the period of time until your retirement), the more aggressive you should be in seeking higher yielding investments.  Conversely, as we approach retirement years and the need to start tapping our retirement plans, we need to re-evaluate our investment strategy and begin to transition into lower yielding yet safer investments.  The following is an Example of one widely accepted strategy with regard to this transition in investment strategy.

Example:  John decided in his 20's to systematically fund for his retirement through his company's Section 401(k) plan. He and his wife, Kelley, also own IRAs.  For decades, they maintained their participation in these arrangements and invested solely in stock mutual funds (John had studied the history of the stock market and determined that the stock market over time would yield an average of 10 or 11%).  John and Kelley, although contributing only a few hundred dollars each month, have accumulated close to $1,000,000 by the time they reach 50 years of age.  Having hit 50, John and Kelley are now looking down the road to their anticipated retirement at age 65.  After researching the subject, John and Kelley devise the following strategy: as of retirement at age 65, they want to be invested in stocks in an inverse percentage to their age (that is, by the time they are 65 years of age, they want to be 65% invested in safer, fixed investments such as bonds and annuities and 35% invested in stocks).  Each year thereafter they would continue to make this apportionment according to their then age.  So, for example, when they reach 70 years of age, their retirement funds will be invested 70% in safer investments and 30% in stocks.

One concern that the couple has is how they attain that initial 65%/35% split when they reach 65 years of age.  They do not want to wait until age 65 to make the transition all at once in the event that the stock market might be substantially down at that particular point in time.  The couple determines that a more systematic transition over time would better fit the bill.  They will start the transition at age 55 and make the necessary reallocations 1/10th per year between the age of 55 and 65.  Thus, at age 54 they would still be invested 100% in stocks.  In the year they attain age 55, however, they will reapportion 6.5% out of their retirement wealth out of the stock investments and into the bond investments (1/10th of 65%).  In the year they attain age 56, they will reallocate their investments such that a total of 13% of their retirement wealth is in safer investments and 87% remain in stocks, and so on until at age 65, 65% of their retirement wealth has been transitioned into safer investments and 35% remain in stocks.

NOTE:  We are living longer now than ever before.  The transition strategy I have illustrated may be too conservative if we end up living ten years more than our parents did.  In light of this, you may want to be 10% more invested in stock at any particular retirement age and/or invest in safer stock mutual funds (see page 90) in lieu of entirely investing in bonds with the "safer" component of your retirement wealth.

A useful tool to assist you in analyzing this issue of transition in investments as you approach retirement age is provided on my Web site (click on Retirement Planning and then Retirement Income Calculator).

Mutual Funds vs. Individual Stocks and Bonds

Virtually all profit-sharing, Section 401(k) plans and IRAs allow the participant/owner to direct the investment of retirement funds.  Almost always a menu of "mutual funds" will be available to invest in.  More rarely, the participant/owner will have the option of investing in individual securities such as a specific stock or bond.  In order to competently analyze which way to go, you must fundamentally understand the difference between investing in individual securities (stocks and bonds) and investing in a portfolio of securities through a mutual fund.

A mutual fund is a convenient method for you to diversify your investment.  Diversification is critical in order for you to protect your long-term investment.  Think about this.  Your greatest risk is not that you will lose money in the market.  As I have mentioned to you, historically the market has been a fantastic place to invest over time.  Thus, the risk that the entire market would crash (as it did in 1929) and stay down should not be a great concern to you (this kind of risk is called "Market Risk").  What is a much more realistic concern are other types of investment risk: Industry Risk and Company Risk.

Industry Risk is where the market as a whole is solid but an industry segment takes it on the chin.  The inherent risk here is greater than that under the Market Risk analysis, but significantly less than what we encounter with Company Risk.  For example, when rumors were afloat a few years ago that cost controls on Medicare reimbursements could be a significant part of adding a pharmaceutical prescription drug benefit to Medicare, publicly traded pharmaceutical benefit  providers to nursing homes lost a significant percentage of their market value across the board.  Concern about heavy-handed government involvement often causes harm to industry segments.

Company Risk is specific to a given company.  If you put all of your eggs in one basket and invest heavily with a single company, you are rolling the dice and gambling to an unnecessary extent.  Yes, you might invest in a Microsoft-type company in its early years and look like a genius.  More likely than not, however, you will find that investing in a single company can stagnate your investment or cause it to decline significantly over time.

All mutual funds eliminate Company Risk.  By investing in a single mutual fund, you will be indirectly buying into the many different companies that the mutual fund has itself invested in.  Most mutual funds also tackle Industry Risk by investing across industry lines.  Some mutual funds, however, are designed to invest primarily or solely in a specific industry segment like healthcare or high tech.  With the industry specific mutual funds, you are hoping the industry segment your fund is investing in will significantly out-perform the market as a whole.  You run the risk that the industry segment will be sideswiped while the rest of the market marches on.

The average investor should not invest in individual stocks and bonds and be subject to Company Risk (an exception would be bonds issued by the federal and state governments where there is no risk of default).  The risk is unacceptable, particularly when we are dealing with your retirement.  Fight the urge to invest in a single company despite all the wonderful things you might hear about that company in the news or on the Internet or from a stock broker.  Please don't do anything but invest in a well-diversified mutual fund.

I will tell you a personal story to drive home this point.  My father-in-law invested heavily in a single company that traded on the prestigious New York Stock Exchange.  This company appeared to have everything good going for it.  Its revenues were growing annually and steadily, as were its net profits.  It was in the nursing home related industry in that it provided prescription drug management for nursing home and other institutionalized residents.  What could be a better company to invest in?  The population is aging, a large segment of the elderly population is residing in nursing home facilities and prescription drugs are growing as a method of healthcare for the elderly.  My father-in-law invested approximately $100,000 in this company, set up a trust account to provide for the education of his grandchildren, and gifted the stock to the trust.

Then came the Medicare scare that I mentioned a little while ago.  Despite the fact that this company has maintained itself as a superbly run company, still generating impressive revenues and net profit, the stock lost more than 75% of its value.  The educational account my father set up, $100,000 in one stock, declined significantly to about $25,000.

The point is, and don't let anybody on TV or in a brokerage firm or friends or family tell you otherwise, NOBODY KNOWS.  All we can do is trust in the future of the American economy generally and diversify.  As I just explained, mutual funds allow us the diversification we MUST have in our retirement portfolio.

Remember, get rich slowly over time.  Don't go for the big score.  Rather be content (and relatively stress-free) to invest in our fantastic economy through a well-diversified mutual fund.

NOTE 1:  Being a political junkie, I must digress for a moment and talk about the connection between political policy and economic growth.  Particularly in an election year, you will hear politicians strongly connecting politics with the economy.  This is largely a scam if the politician is connecting certain affirmative steps taken by the government with economic growth.  Not too long ago, Japan tried to meld government action and subsidies with Japanese companies and destroyed the Japanese economy in the process.  Any reputable economist will tell you that the less government does the better we are with regard to economic growth.

A reasonable-not excessive-level of regulation and taxation is what is called for.  Otherwise, too high regulatory and tax costs make our American companies non-competitive in the world market and/or simply add to the cost of doing business.  As with any cost of doing business, the company will add tax and regulatory costs to the price of the goods or services being sold.  In that manner, the higher taxes and regulatory costs that a politician is screaming for ends up being just another regressive consumption tax (falling disproportionately harder on those least able to pay it) in addition to making the company less competitive.  In other words, businesses do not pay taxes; they charge taxes.

NOTE 2: Like most of my friends in college in the early 1970's, I would probably have been accurately described as a borderline Socialist.  But as I aged and matured-and most importantly, became better educated–I realized that American capitalism is a far sight different from how it is betrayed by the Hollywood crowd and the highbrowed intelligentsia that still largely populate our educational institutions.  Rarely is there a greedy “Capitalist Pig” or conspiracy underlying an economic concept or trend such as the price for oil.  Almost always there are market forces at work that are beyond the control of specific business people.  Indeed, this is the fundamental beauty of capitalism.  Barring a major monopoly or undue governmental pressures, free markets are largely beyond the control of humans and will naturally seek a logical equilibrium.

Picking the Right Mutual Fund

Let's rehash the bidding at this point.  We now have learned that investing in individual stocks and bonds is a bad idea for the average investor.  Rather, investing through stock or bond mutual funds allows us to significantly diversify our investment and provide insulation against Company or Industry Risk.  We have also learned that the longer until retirement, the more risk we generally should assume.  To state this last point a little differently, the longer you have until retirement, the more inclined you should be to invest in stocks as opposed to bonds or money market funds.  Having established these general parameters, we still have some work to do.  Why?  Not all stock and bond mutual funds are alike.

Stock Mutual Funds

The investment companies that provide mutual funds might label them somewhat differently, but most provide different categories of funds with a different investment orientation.  There can be a great number of variations in this investment orientation, but generally speaking we can establish five categories that just about every mutual fund company will offer (again, the names given these different funds might vary from mutual fund company to mutual fund company).

We will talk about risk tolerance relative to these categories momentarily, but first let's describe them.  Let's take a look at one of my favorites, TIAA-CREF.  TIAA-CREF is one of the world's largest investment companies.  Up until a few years ago, only employees of educational institutions, tax-exempt organizations and governments could invest through TIAA-CREF in that TIAA-CREF could only receive Section 403(b) Annuity contributions (page 77).  In more recent years, the general public has been permitted to invest with TIAA-CREF.  I am advising you to strongly consider this company as a good repository for some or all of your IRA monies (your investment options in an employer-maintained retirement plan like a pension, profit-sharing or Section 401(k) Plan will rarely offer TIAA-CREF as an investment option).  The TIAA-CREF Web page may be accessed from my Web site-click on Retirement Planning then Mutual Fund Companies.

Now let's see how they divide up their stock mutual funds and what the risk/return strategy is within those different funds:

An International Fund - An International Fund invests in worldwide companies (many or most of which are non-U.S. companies) that are stable international firms.  As I mentioned to you earlier in the Retirement Planning analysis, America is the safest place in the world to invest.  Nonetheless, international firms headquartered outside the United States frequently trend upward in value at times when United States companies aren't doing as well.  Therefore, if we are trying to completely diversify our stock strategy, we may want to mix some international stocks into our portfolio.

A Growth Fund - In a Growth Fund the fund manager is attempting to beat the stock market's return as a whole by focusing on companies that appear to be undervalued or poised for extraordinary growth as has occurred recently in the high tech and biotech industries.

An Indexed Fund - An Indexed Fund seeks to track the rate of return of a common stock market index like the S&P 500, the Dow Industrial, or a broader based index such as the Russell 3000 (which indexes the stocks of the 3,000 largest U.S. companies traded on public stock markets).  The fund manager attempts to duplicate the rate of return on the index by investing proportionately in the same stocks that make up the underlying index.  Since there isn't much guess work here (the fund manager is simply proportionately buying the same stocks that make up the index), the expense ratio (discussed in more detail under Doing Your Own Mutual Fund Research on page 94) is typically lower then on other stock funds.

A Growth and Income Fund - A Growth and Income Fund invests primarily in larger, well-established companies with a good dividend paying track record.  Ideally, the fund manager hopes to have the value of the underlying stock grow at a reasonable rate.  Additionally, the fund manager hopes to supplement that appreciation in value by above-average dividends paid by those same companies.

A Managed Allocation Fund - A Managed Allocation Fund will invest primarily in stocks but will also invest a significant amount of the fund's wealth (perhaps 25% to 40%) in bonds as well.  The idea here is to provide some hedging on risk/return as will be discussed in the next paragraph.

Risk/Return on Stock Mutual Funds

As we noted earlier, stocks generally have a higher historic rate of return than do bonds, but are riskier investments.  Similarly, within stock mutual funds, there is a risk/return analysis to do as well.  Focusing on the general categories of stock mutual funds I just described to you, the International Stock Funds and the Growth Funds have a higher rate of return in good times but tend to take it on the chin in poorer times.  Therefore, the higher rate of return is tempered by the thought that it could turn around quickly in bad times.  The Indexed Funds have a lesser rate of return than do the Growth and International Funds but are deemed less risky.  The Growth and Income Fund is less yielding still but also less risky.  And lastly, the Managed Allocation Fund (since it is hedging on the risk feature by investing significantly in bonds) has the lowest rate of return of the stock funds but is the least volatile.  Thus, going from riskiest to least risky in our general description of stock mutual funds we move from the International Stock Fund to a Growth Stock Fund to a Indexed Fund to a Growth and Income Fund to a Managed Allocation Fund.

What should you do?  There is no absolute answer here, but keeping to the book's KISS philosophy wherever possible, I will at least tell you what I do.  My personal belief is that, if you are under 50 years of age and plan on retiring at age 65, you should be invested primarily in stock funds.  This view should become much more the rule the younger you are.  I am 52 years old.  In my own personal retirement plan, I have been invested entirely in stock funds.  Still I diversify within those stock mutual funds.  I have not followed the advice of some in the industry and plopped my entire nest egg in Growth Funds. Rather, focusing on the stock mutual fund options I just gave you, I divide my retirement wealth between the first four stock funds in a way that favors American companies:  The International Fund (10%), the Growth Fund (30%), the Indexed Fund (30%), and the Growth and Income Fund (30%).  Thus, I am diversifying within the stock funds and giving up a possibly higher rate of return in return for tamping down the risk factor somewhat.

NOTE:  Some investment advisors go overboard in an attempt to diversify within stock mutual funds.  For example, I have seen situations where the investor is placed only in stock mutual funds, but is invested in 15 or 20 different stock mutual funds.  The attempt here is to more significantly diversify (and maybe to enhance the commission paid to the investment advisor).  I don't necessarily like this.  If you do your homework (see Picking the Right Mutual Fund below), you will probably find that you can plop your nest egg into a reasonable number of funds that sufficiently diversify across the market (which is what I do, as I just described).

Use your common sense.  Don't go wild investing in too many different funds.  Conversely, if you limit your investments to just a few funds, make sure that each fund has a good historic track record and is itself internally well-diversified (like a Russell Indexed Fund).

Bond Mutual Funds

Most mutual fund companies will provide a number of bond funds.  For example, TIAA-CREF has multiple bond funds in its mutual fund options.  These bond funds invest primarily in various high-grade bonds (issued by both governments and private companies) of varying maturities. As we discussed earlier, bonds are generally considered safer (though lower yielding) investments relative to stocks.  Still, there is some volatility to bonds and the inherent value of them change continually.

Bonds vary in economic value depending on a number of variables.  When you invest in bonds the underlying value of the bond itself will continually change.  Here is why.  Remember that the interest payments on bonds are typically fixed.  When I pay $1,000 for my $1,000 face amount, 10-year bond, paying a fixed rate of interest of 5%, the market is saying an 5% interest yield is a fair rate.  Let's say a year later the market rate of interest goes up to 7%.  Why would somebody pay me $1,000 for my bond paying 5% when they could go out and buy a newly issued bond for $1,000 that paid 7%?  Therefore, the inherent value of my bond would decline from $1,000 to reflect this difference.  Conversely, if the market rate of interest went from 7% to 5%, my bond paying a fixed rate of 7% would go up in value as it is now paying more than a market rate of interest.  In this manner, both individual bonds and bond mutual funds will go up and down in value continuously as market rates of interest change.

There is also a risk/return variable between short- and long-term bonds.  A short-term bond is generally lower yielding since it is relatively safer than long-term bonds (safe both from the interest variation I just illustrated in the prior paragraph as well as the aspect that there is less risk that the issuer will go bankrupt before the maturity of the bond).  A long-term bond should pay a slightly higher interest yield to offset the two risk factors noted in the prior sentence.  With a government bond, the risk that the issuer will go bankrupt is virtually non-existent.  So it pays to check the rates to confirm the short-term vs. long-term dichotomy I just mentioned.  This is particularly true if you plan on holding the bond to maturity.  This last approach (holding a bond until maturity if you invest in individual bonds) is strongly recommended by a number of respected financial advisors.

In the case of mutual funds, the investment company may orient its bond mutual funds so that one invests primarily in short-term bonds while another invests primarily in long-term bonds.  An illustration of this can be viewed on-line by looking at the TIAA-CREF mutual fund page (go to my Web site, click Retirement Planning then Mutual Fund Companies and then TIAA-CREF).  You will see some good examples of varying types of bond funds.  This company's Short-Term Bond Fund conforms to what I just told you relative to Short-Term Bond Funds.  Similarly, the Bond-Plus Fund is a longer-term bond fund significantly invested in high grade bonds.  Additionally, TIAA-CREF offers a High Yield Bond Fund.  This Fund obtains higher than normal rates of return by investing in the bonds of lower-rated companies (called “junk bonds”).  As I mentioned to you earlier, if the credit rating of a company is not optimum, the company will have to pay a higher interest rate on its bonds in order to sell them.

Asset Allocation and Establishing Your Risk Tolerance

What have we learned so far?  Generally speaking, stock mutual funds have a higher historic yield than do bond funds, yet stock funds are riskier than bond funds.  Bond funds provide a stabilizing force in an investment portfolio.  If the economy takes a distinct turn for the worse, the inherent value of bond funds generally will rise at the same time that stock funds are falling.

Having made my pitch to be more aggressive if you are a younger investor, let me remind you of the theme of this book, keeping things simple (the KISS strategy) and relatively stress-free.  If you are the type of person who is going to lie in bed awake at night every time the market takes a temporary dip, then my personal strategy is not for you.  After all, I am trying to advise you on how to make your life more secure and comfortable, and if you don't have the personality that allows you to comfortably ride the long-term wave, you need to face that reality.  But how do you objectively come to a determination of what is a realistic risk tolerance for you?  Ultimately, the function of the risk tolerance analysis is to provide you with an optimum break down of what you should invest in vis-à-vis different types of stock and bond funds.

If you work for a company and you are doing your retirement investing through your company's profit-sharing, Section 401(k) or Section 403(b) plan, generally you will have a set menu of stock and bond funds that you can invest in.  Either your company's human resources or employee benefit's person and/or the investment company providing the underlying investments can provide specific advice to you with regard to doing a risk tolerance analysis relative to that menu of investments.

How about doing it on your own?  I have provided to you on my Web page (click Retirement Planning then Analyzing Your Risk Tolerance), the TIAA-CREF material to help you determine your risk tolerance (if you do not have computer access to the Web Link, the telephone number for counseling services at TIAA-CREF is 800-842-2776).  The Schwab site will also assist you in evaluating your risk tolerance.

NOTE:  Incidentally, if you are wondering, TIAA-CREF does not pay commissions or otherwise compensate individuals like me who refer business to them.  My interest in the company, and my recommendation of it to you, is that it simply is one of the finest mutual fund companies in the country and its expense ratios are exceptionally low.  Study the company yourself via the Web links I have given you as well as under the next heading, Doing Your Own Mutual Fund Research.

Doing Your Own Mutual Fund Research

At this point, you have an understanding of how stock and bond funds work over both the short and long-term.  You have also thought about my statements on an appropriate long-term investment strategy and you have further done a risk tolerance analysis.  At this juncture, let's say you have determined to invest 25% of your retirement funds in an S&P Indexed Fund, 25% in an International Fund, 25% in a Growth Fund, and 25% in a Bond Fund.

As you finish your asset allocation and risk tolerance analysis, you will have various mutual funds recommended for purchase.  Whether you are investing through a company sponsored plan or on your own in an IRA, your analysis is not quite finished.  You may want to do additional research on a specific fund that has been recommended to you.  You may, for example, have the ability to invest in a variety of different funds in the same category.  They all sound good and now the question is whether the Fidelity Growth Fund is better than the Soloman Smith Barney Growth Fund is better than the TIAA-CREF Growth Fund, etc.  Each of these funds will have a largely unreadable prospectus that has been fashioned more for legal cover than providing a good summary of relevant data for the typical investor.  Is there anything that provides a short and precise summary of relevant data?  Yes, the big mutual fund rating service, Morningstar, does exactly that.

This service can be accessed through my Web site (click on Retirement Planning and then Morningstar Ratings).  Morningstar will rate a fund from one star (worse rating) to five stars (best rating).  Additionally, Morningstar will show the year-to-date, one-year, three-year, five-year and ten-year returns for the fund if the fund has been around that long.  Although relevant, you should not become overly influenced by the more recent returns but should focus on the longer three or five-year return record for the fund and compare that return to industry norms which Morningstar also provides.

Also, the Morningstar service provides a feature that I find very helpful relative to risk/return ratio.  Morningstar will note whether the particular Fund is below, at or above average return and will also note whether it is below, at or above average for risk.  A good strategy might be to look for four star funds (a five star fund might be over-bought because of its highest ranking) where the return is above average but the risk is below or at average.

Additionally, and of great significance, Morningstar will also note the expenses charged by the fund managers.  A fund's maintenance expense can vary widely from fund to fund.  If the fund has a good historic and current rate of return, you should be willing to pay a higher expense ratio.  However, bear in mind that an additional 1% expense comes off the top and could have a significant long-term effect.  For example, a fund with a 1% expense charge that is grossing 12% for the year, will net you 11%, whereas a fund grossing 12% with a 2% expense ratio will net you 10%.  If that rate of return held for two decades of investing, the 1% difference would cause you to have $41,000 less in the higher expense fund than in the lower expense fund if you invested $5,000 per year.

Morningstar will also note any "load" associated with purchasing the fund.  The load is a one-time fee usually used to enable the mutual fund company to pay commissions to any salesman/broker.  Loads in the 4-6% range might be charged up-front on the initial purchase (usually associated with "A" funds) or if the purchaser sells the fund within four years of purchase (usually associated with "B" funds).  All things being equal, you should strive to purchase "no load" funds such as those offered through Schwab (go to my Web site, click on Mutual Fund Companies and then Schwab).

Lastly, Morningstar has an excellent library of articles on mutual funds and other investment topics.  You can access this information from my Web site by clicking on Retirement Planning then Morningstar Ratings.