1. What are the goals of the fund?
Before you select a mutual fund, you first ought to know what your goals are and make sure you select a fund with similar goals. Obviously, every fund's goal is to make a profit for the investors, but how much risk you are willing to take and what industries you want to invest in are up to you. There are many fund families that now offer "target retirement" or "life strategy" funds which change with you as you get older. This is a great way to simplify your diversification if you don't feel comfortable doing that yourself.
2. How much are the fees?
Every mutual fund is required by law to disclose their fees to you in the prospectus (that booklet you are supposed to read before you invest). Typically funds come in two flavors, "loaded," and "no-load". A "loaded" fund will typically charge a fee either when you buy ("front-end loaded") or sell ("back-end loaded") the fund. This comes out of the money you invest. Typically these fees are about 5%.
The second type of fee is the yearly fee the fund charges to be a member of the fund. These fees can range from 0.05% up to 3%. There have been several academic studies to show that the only accurate predictor of which funds will produce better returns for their investors, are the ones with the lowest fees. Makes sense, right? If all managers basically perform the same over time, you, as an investor, will do better with the one that charges you less fees.
The third, and often overlooked source of fees comes in the form of transaction fees. While in a sense these are transparent to the investor, the effects are felt nonetheless. As the fund managers buy and sell the stocks in the portfolio, they create expenses both in the form of trading costs as well as taxes. So funds with a higher turnover percentage (for example, 50% would mean they turn over half of their portfolio every year, holding an average stock 2 years) would generate more of those fees, and create more drag on your total return as an investor than a fund with a 10% turnover.
3. Is previous performance an indicator of future results?
The short answer is, no, they are not an indicator of future results. And even though every fund is required by law to remind you of that, people pour billions of dollars every year into the latest "hot" fund. Again, the only proven indicator of better future results in the future is lower fees. Interestingly enough, the one rule that does seem to hold true is that poor performance over several years does seem to be an indicator of poor performance in the future.
4. How does this fit with the rest of my portfolio?
This is a crucial decision. When I was a younger, less experienced investor, I thought I was diversifying my portfolio because I had 4 or 5 mutual funds. However, I had no idea how those funds fit together, and how it affected the overall picture known as my "portfolio." Each fund will list in their prospectus the percentage they invest in each type of stock and bond, and you should track the percentage of each in your overall portfolio. Furthermore, you should have targets for Domestic and Foreign equities, Small/Mid/Large caps, and Bonds. There are various guides for helping you decide your allocations, but mostly it is an individual decision based on your beliefs about the market and your financial picture (such as when you will need to begin withdrawing money).
5. Would I be better off in an ETF?
ETFs (Exchange Traded Funds) have come on the scene in the last few years and made quite an impression. Although they act much like a mutual fund (holding baskets of stocks), they trade on the stock exchange like a stock. The good news is that for most small and medium investors, their is very little difference between a mutual fund and an ETF. ETFs generally track a certain index, although as time has gone on, those indicies have gotten more and more non-traditional. Because they are generally not "managed" funds (following an index instead of active management), the fees are typically lower than a managed fund, and about the same as an indexed mutual fund. Be careful, however. Just because it is an ETF, doesn't mean it is well diversified -- some can be quite narrowly focused.