A Three-Part Framework for Choosing Funds That Last

When you’re building a long-term investment portfolio, you need a strategy you can stick with through any market. 

In this video, Daniel Sotiroff, Associate Director, US Passive Strategies, shows how to evaluate long-term investments in Morningstar Direct. Using a simple three-part framework, you can look for funds that are cost-effective, sensible, and repeatable, and find the investment clarity you need. 

This video discusses findings from Morningstar’s US Active/Passive Barometer Report. You can read the full report for free.

Dan Sotiroff: Hi, I'm Dan Sotiroff, Senior Manager Research Analyst for Morningstar. 

When you’re building a long-term investment portfolio, it’s not just about picking a fund and hoping for the best. To build a robust portfolio, you need a strategy you can stick with through any market. In this video, I’ll show you how I use Morningstar Direct to evaluate long-term investments using a framework that’s cost-effective, sensible, and repeatable.
As long-term investors, we’re often trying to build portfolios to achieve a certain goal. Having an idea of what you’re looking for provides context for decision-making, so we can better spot opportunities and mitigate risks. Maybe you want an investment to complement an existing portfolio.  

Maybe you’re nearing retirement and want more income, or to align your portfolio with personal values. To do this, you might focus on certain strategies or categories, like high dividend yield or high-income bonds. Or you might consider different market segments, like small-cap, large-cap value, or growth. 

The question is, how do you find the right fund to meet your needs? With Morningstar Direct, you can validate each of these components and find the investment that truly fits your strategy. 

Let’s see how this works with a specific example. We’ll start with a basic search in Morningstar Direct for dividend ETFs in the large value category to create an initial investment universe. From there, we’ll narrow our options using the three key parts of our framework. Let’s start with the Schwab US Dividend Equity ETF, ticker SCHD. 

The first step is to ensure an investment is cost-effective. In Morningstar Direct, we can quickly do this by comparing two straightforward data points: the expense ratio, or what you pay for the investment, and annual turnover, a proxy for the fund’s implicit trading costs. 

A fund with low turnover is more likely to follow a cost-efficient strategy. As a starting point, let’s keep that below 40%. Similarly, because this is a really competitive category, let’s limit our search to funds charging less than 10 basis points. From here, we can easily see which funds pass the test. SCHD is a great example of a low-cost, low-turnover fund. 

Next, we want to see if the fund’s holdings are sensible and aligned with its objective. We can pull up SCHD’s dashboard to instantly see its largest holdings and its sector composition over time. You can also see a fund’s average characteristics, like its valuations and profitability, to confirm it’s structured the way you’d expect. 

Finally, we want to know if the fund’s success is repeatable. We can use a few of Direct’s unique tools to find out. The first is Style Trail, a feature on our interactive charts that shows how a fund’s investment style has moved through the Morningstar Style Box over time. This helps you spot notable changes in the fund’s strategy. 

Another underappreciated chart that I use every day is the Excess Return chart. It gives you a clear visual of a fund’s performance against its index, helping you quickly identify periods of outperformance or underperformance. You can mouse over the chart to see how its returns compared with the benchmark over a specific period. To take our analysis even further, the Attribution Tool, a powerful holdings-based model unique to Morningstar, can show us why a fund has outperformed. 

For example, with SCHD, we can see that positive contributions from factors like style and yield have helped its performance over the last decade. This tool gives you the confidence that a fund’s performance is due to its intended strategy, and not just luck. 

So when you’re looking to build a long-term investment portfolio, remember to focus on investments that are cost-effective, sensible, and repeatable. 

Discover how Morningstar Direct can help you find the investment clarity you need. Start a free trial of Morningstar Direct to begin your own analysis.