Choosing the Right Mutual Fund
A mutual fund is an investment program funded by shareholders that trades in diversified holdings and is professionally managed. The investment fund pools money from numerous participants and uses the capital to purchase securities. Because any income or profit from mutual funds are tax exempt, these pooled investment vehicles are very popular among investors.
Like all securities buying, a risk is involved in even the “safest” of mutual funds. The level of risk in a mutual fund depends on what it invests in, its portfolio. Usually, the higher the potential returns, the higher the risk will be. Generally, though not always, stocks are riskier than bonds.
With over 8,000 mutual funds available to the public, the goal is to find the one perfect for you. From both psychological and financial points of view, risk is tremendously important to consider. For example, many can’t mentally accept dramatic swings in portfolio value, even if the end result turns out positive. Many investors often panic and attempt to “cut their losses” at the first sign of a decline. This is often the wrong decision, and the investor loses out on not only making back their losses but also acquiring significant future earnings. The bottom line is high fluctuation funds are too frightening for many investors, despite the potential for making great profits.
Especially in regards to retirement planning, you should be seeking funds with low fluctuation. You don’t want to be going to bed every night wondering if the next market shift will leave you in situation where you will be working until your final day on earth. A portfolio heavy on bonds will likely be your best option.
Before you acquire shares in any mutual fund, take the time to identify the goals you have for the money being invested. Looking to make significant money within the next 4-5 years and supplementing a retirement that is decades away will require radically different approaches to investing.
Once all those considerations are made, your list of 8,000 mutual funds should be a bit smaller. That means its time to look at track records. If you’re going to redesign your home, would you feel comfortable hiring a contractor who no one has ever heard of and has never done a job? Of course not. The same precedent applies to selecting a mutual fund.
Most importantly, understand that even guesswork can accomplish a great year for a mutual fund. By only looking at a year or two of trends, you might be missing out on the bigger picture. Try to avoid any fund that has not been established for at least 5 years. However if those 5 years have seemed successful, but the mutual fund manager has changed, those last years don’t really matter – the person who made the decisions during those years is gone. Look for funds that have accomplished their goals on a long-term basis and management consistency.
Common sense plays a greater role in choosing a mutual fund to invest in than paying attention to the day’s hot fund in the financial news. If Jim Cramer is yelling about a fund on Mad Money, you’ve probably missed the boat on that one.
Take your time, do your research and invest wisely. Your choice of mutual funds could be the most important decision you ever make.
