7 Steps to Happiness; or, Think Before You Buy

If you are going to be happy with your mutual funds, you need to remember why you picked them. But if you choose arbitrarily, you don’t have any guidelines when you sell, either.

Here are the steps I go through before buying a new fund. Maybe my process will help you to develop and refine your own.

1. Determine why I want or need a new fund.

Investing is a means to a better future, although it also seems like a hobby. Never confuse the two. That means no impulse buying, no chasing hot funds--in short, no moves that don’t fit a bigger strategy.

Instead, the process for picking a fund starts from within, where I decide what I want this money to accomplish. That sets my goals and expectations.

It also keeps me from staying with laggards and unnecessarily complicating my life. I don’t need two aggressive-growth funds. If this money is to be managed for fast growth, I can add it to my existing fund; if I have lost faith in my current selection, then I should be making a change anyway.

2. Find funds that meet my needs.

If I want or need a new fund, I quickly pare the field by following my own rules and preferences.

Personally, I don’t waste time with funds that do not offer automatic-investment plans and telephone-redemption features or that charge sales loads. There are many terrific load funds out there, but I don’t want to pay a sales fee after making the effort to do my own research. You might want check-writing, 24-hour telephone service or something else.

3. Learn the story of the fund or its manager.

Investing is a leap of faith. You need something to base that faith on, whether it is the expertise of an investment genius or the simplicity of a style of investing, such as indexing. Either way, I look for a compelling reason to go with a fund. You can often find that reason in the fund’s newsletters; the best managers in the business tell you a lot about their style and discipline by what they send to shareholders and prospective investors.

This factor has become increasingly important to me. Without a thorough understanding of the fund and the manager, I may not have the confidence to stay put.

4. Examine performance, particularly over the long term.

This used to be one step higher in my process. With the stock market of the 1990s making almost every fund look pretty good, I find performance numbers less compelling. Still, my initial cut is for funds in the top 25% of their peer group over the last five years.

I also look for volatility, taking the fund’s worst quarter and forecasting it over a year to tell me what might happen if things get scary. I won’t buy a fund with volatility that frightens me.

This is easiest using data from a ratings service like Morningstar or Value Line, or in quarterly newspaper or magazine reports.

5. Choose the finalists and call for three to five prospectuses.

I read these to make sure a fund’s holdings are consistent with the manager’s discipline, and to check out what the fund is allowed to invest in, which is a key to how the portfolio could change in the future. If the list of holdings makes me nervous, I move on.

6. Look at expense ratios and turnover.

This is how I weed my short list. A fund is entitled to make money off me, but higher-than-average expenses are a turnoff. Low-turnover funds tend to be tax- and cost-efficient.

I want funds I can trust in all market conditions. In a sour market, funds with the big expense ratios and high turnover are likely to suffer more than the rest.

7. Write the check.

By now I’ve come to a decision. I sweat out my choices but am excited by their potential. If that rush is missing when you sign a fund’s paperwork, something is wrong; start the process over again.

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Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at jaffe@globe.com or at the Boston Globe, Box 2378, Boston, MA 02107-2378.