Put investment knowledge to the test now and then


On the first day of fifth grade, my oldest daughter was given a test to determine how much math knowledge she had retained over the summer. There was no time to study and prepare, just a quick quiz to challenge her memory and number skills.

It's the kind of pop quiz fund investors should periodically be subjected to. Over time, people tend to forget a lot about their funds. But funds and investor needs change. That's why investors should periodically take a "Basic Knowledge of My Funds" exam. It's not a hard quiz, just the bare minimum you should know about your investments.

If you can't answer these basic questions, plow into a prospectus, head to your fund company's Web site or revisit your portfolio-building strategy for a refresher course:

What is the fund's investment strategy and market-capitalization or bond-duration profile? Most funds can be sized up in a few words. Think "large-cap growth" or"small-cap value." It's important to remember what a fund did when you bought it - because objectives can change - and to make sure that all of your funds don't pitch their tent in the same area of the market.

Ideally, you can describe a fund in a full sentence that would justify your selection to, say, your mother, your children or your Uncle Frank. You get credit for the three-word answer, but add points if you can be more thorough, with something like "This fund buys stocks in small companies that it thinks are undervalued and ready to pick up steam," or "This fund buys medium-duration government securities to produce a safe, steady income stream."

Who is the manager and what is the investment style? If you are paying for leadership, you should know from whom you are getting it, whether it is a star manager, a team of specialists or a passively managed attempt to match the index.

Moreover, funds change when managers change. The person running the fund when you bought it may no longer be in charge.

What is the fund's expense ratio? Costs are a major factor in performance. As such, they generally play into fund selection. But expense ratios can rise (they seldom come down), and you don't want to be a victim of "cost creep." The average domestic stock fund, according to Morningstar Inc., has an expense ratio of 1.41 percent, while the average taxable bond fund carries costs of 1.12 percent. Ideally, your funds will be well below those levels and will not have risen significantly.

How is the fund rated by independent experts? Like the expense ratio, ratings change. That's one excuse for getting this question wrong. But it's important to know if and when ratings change, whether you are relying on Morningstar, Lipper, Value Line or any other ratings agency or newsletter.

A downgrade is discouraging. (Morningstar changed its famous star system over the summer, altering ratings for countless funds. To see where ratings stand now - while also checking investment style and more - use the "fund compare" feature at www.morningstar.com.)

What is the fund's role in your portfolio? You won't find this in the prospectus, but every fund should have a job within your portfolio, generally to cover a certain asset class and provide diversification, safety, aggressiveness or some other key characteristic. If you don't know the fund's job, it's difficult to say whether the fund is doing it well, no matter how good or bad the performance numbers look.

Further, you might outgrow a fund, so that something appropriate for a 40-year-old no longer serves much purpose for a 70-year-old. If you find that the fund has no specific job, you might want to make a change.

Extra credit: What is the fund's sector profile? Some funds have specialties, falling into a category such as "large-cap growth" but emphasizing stocks in certain sectors, such as technology or financial services. These preferences may change over time, especially if managers change, but they say a lot about how a fund achieves its returns. Moreover, they show whether a manager is sticking to a strategy - keeping sector weightings roughly the same - or trying to outmaneuver the market.

Says Russel Kinnel, director of fund analysis at Morningstar: "You'd think people would know these basics about their funds, and maybe they do when they first buy it. But this is the stuff people tend to forget, which is how they wind up a few years later really wondering what the heck has been going on."

Charles A. Jaffe is mutual funds columnist at The Boston Globe. He canbe reached by e-mail at jaffe@globe.com or at The Boston Globe, Box 2378,Boston, Mass. 02107-2378.

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