For most people, when it comes to investing there aren’t a lot of fancy options out side the stock market. Some dabble in real-estate, but beyond that there’s not much for the casual consumer to invest in that’s worthwhile. Fortunately there are plenty of good stocks and mutual funds to choose from, but navigating through the thousands of choices can be a bit confusing. Take a moment and consider these caveats before looking at mutual funds.
Managing Time and Risk. Your investment should match the time period you plan on leaving it invested. Money that will be needed in the short term should be in funds that take much less risk and have low volatility, such as a money market fund. Investments which do not need to be taken out for decades can be placed in more aggressive funds which will do very well over a long period of time, but have great amounts of volatility.
Watch Out For Fund Expenses. Over a long period of time, high mutual fund expense ratios can degrade a mutual fund’s performance by quite a large measure. Expense ratios are the percentage of your mutual fund you will pay each year to the mutual fund manager to invest the money for it. Generally, the lower expense ratio, the better, assuming all else is equal. Actively managed funds usually have higher expense ratios, because a mutual fund manager is actively picking out new stocks for the fund to invest in.
Be Wary of “Best Fund” Lists. Each year many financial magazines and publications will come out with their list of best mutual funds. The reality is that mutual funds will vary from year to year, and that the “best” one for the year, might do quite poorly the next year. If the top performer was a sector-specific fund for an industry was doing really well one year, and a bad piece of news happens for the industry, your mutual fund could definitely take a turn for the worse.
Watch out for Taxable Distributions. Mutual funds will quite often make a taxable distribution near the end of the year. If you plan on investing in a fund that provides one of these, find out when the fund plans to distribute dividends. Investing just before a taxable distribution will return part of your investment to you, but it will be taxable income and will not increase the value of the account.
Track Record is King. The single most important thing to look at when choosing a mutual fund is its historical rate of return. Compare how well the mutual fund has done compared to the S&P 500 and the Dow Jones Industrial Average and other mutual funds in the same category. Make sure your mutual fund choice is doing at least as well as the major index funds.
Get a Prospective. If you plan on investing in a mutual fund, request a prospectus! The prospectus will disclose any risks taken with your money, amongst other very important topics.
Diversify. The old saying is true; don’t put all of your eggs in one basket. Never put all of your money in one company, and it’s probably not even a good idea to put it all in one mutual fund. Even if you think you have found the best investment in the world, something could always happen to it. When choosing mutual funds, make sure they are not all in the same sector, the same market capitalization, or even the same economy. You’ll want a good mix of investments in different sized companies in the US and abroad.
Not all mutual funds are the same. Be sure to choose the best mutual funds for your investing goals. Learn what to look for and how to avoid common problems that many beginning investors make.