Mutual Funds, what you really know? Newcomers to the world of investments may find the words, “mutual funds,” intimidating. With a wide array of funds to choose from, all clamoring for your attention, it’s easy to be swayed by promises, especially if you don’t have a clear picture of how mutual funds work, or what they’re supposed to do for you.
Don’t jump in before you’ve done your homework. As with other types of investments, “knowledge is power,” so read, research and test the waters before you commit to anything.
Not sure exactly where to start? No problem, here are some priceless tips for navigating through the mutual funds minefield successfully:
Table of Contents:
Acquire a Decent Understanding of Mutual Funds
Most people have heard of mutual funds, but many don’t know how to invest in them. Let’s start by defining mutual funds as a collective investment. An investment company oversees and maintains the mutual fund by collecting resources from a number of investors. They use funds they collect to purchase stocks and other investment instruments.
The United States government is quite strict with mutual funds, requiring the investment company to register the fund with the Securities and Exchanges Commission. It also requires that a registered investment advisor be instated as a fund manager. This is to ensure that the stocks and securities purchased for the mutual fund are in line with the best interests of each investor. There are different types of mutual funds, including:
- Index vs. Actively Managed Funds: An index fund is the opposite of an actively managed fund because it is passively managed. It simply buys and holds the stocks similar to those in a chosen benchmark index. The actively managed fund is a lot more aggressive and seeks to beat the market’s performance.
- Load Vs. No Load Funds: The term, “load,” refers to payment for broker guidance or advice. If you’re not getting any assistance from an advisor, then you don’t need to pay the load amount. As a newcomer, receiving much needed extra guidance can be a good thing. Consider this before deciding to skip load funds.
> Related: How to Invest in Real Estate (The Basics).
Under the Magnifying Glass: Analyze the Mutual Funds
There are a significant number of mutual funds out there today. Many people who start the search for a mutual fund often find themselves wondering, “With all these choices, how am I supposed to choose the right one for me? Use these commonsense tips to guide you:
- Do your research. You can get the information you need before you start investing in mutual funds online. One example is Kiplinger’s Fund Finder. It offers helpful information regarding the mutual funds available. It also provides indicators, such as volatility, past performance and expense ratios. It contains many details that can help you compare and identify the right mutual fund that suits your personal risk threshold and investment style. Other sources are Morningstar and Thomson Reuters’ Lipper Leaders service.
- Examine the historical data. Though it is true that past performance isn’t always indicative of future success, it still gives you a good idea as to the fund’s potential for significant returns.
- Look at the fund manager’s abilities. However, if the fund manager is a newcomer, obviously you can’t consider their past performance. A reputable fund manager will provide testimonials, references and/or reviews for you to check.
- Know your personal risk threshold. If you’re looking towards a long-term investment, then you need a mutual fund with low turnover ratio. You don’t want a mutual fund that buys lots of trendy stocks then sells them off immediately afterwards. You’re probably looking for a mutual fund that invests in low-risk, but less volatile stocks.
- Consider the tax factor. You probably will want a mutual fund that doesn’t require a hefty tax payment, because this lessens your investment return considerably.
Getting into Mutual Funds: Starting Right is the Key
So, you’re probably wondering if a mutual fund investment is for you. If you’re still on the fence, it helps to educate yourself first. Here are three simple but effective tips that should help you with the decision.
- Start with one mutual fund. Don’t try to get into mutual funds in a big way. This is your money we’re talking about, and taking prudent steps is always a good idea. If you want to see what a mutual fund can do for you, this is the best option for testing out the waters.
- Practice the Five Percent Rule. The Five Percent Rule is a simple little trick that reminds investors not to put all their eggs into one basket. If you’re new or just trying out a new investment vehicle, invest 5 percent of your total portfolio to start. You can always add more when you’re sure it works for you.
- Understand the concept of rebalancing. Many people think rebalancing is all about buying and selling obsessively whenever the market experiences any kind of shift. In reality, rebalancing means regular re-assessment of your portfolio to see which vehicles work, and which don’t.
If your mutual funds aren’t working out great for you after six months, sell them off and invest in the other vehicles in your portfolio that are showing great returns. It doesn’t mean that you have to be obsessive, but regularly rebalancing can help you keep your portfolio healthy and prevent a lot of grief.
Mutual funds can bring you some handsome returns, if you play your cards right. Do your research and start small until you know the rules by heart. Once you know what works for you, invest more, or re-balance your portfolio.
Hopefully, you now understand the ins and outs of navigating the mutual funds minefield. To read some helpful platform reviews, be sure to visit the InvestingIQ reviews page. For more information on mutual funds, read this article, “The Risk Factor: 6 Steps for Evaluating Investments.”