Investing alone can be as awkward as singing karaoke — it might make you feel self-conscious and unsure if you’re doing the right thing. That is why many small investors opt for mutual funds, which grant them access to professional money managing services.
Investing in a mutual fund is a big decision, with many factors to consider. Here is a guide to choosing the right mutual fund for you:
Understanding a fund’s investment style. A strong mutual fund should have an explicit investment strategy from the start. A lack of strategy could result in a style drift — straying from the stated investment objectives. A style drift could happen for a number of reasons, such as a changes to the portfolio, management restructuring or company growth. Investors tend to prefer more consistent funds with limited drift, as managers may start to take larger risks in order to avoid underperformance. However, you still want an element of style drift because completely sticking to the plan limits the fund’s ability to respond dynamically to market forces. When choosing a mutual fund, keep an eye out for those that are consistent and leave room for inevitable, natural divergence.
Assessing risk and returns. When it comes to investing, the level of risk usually corresponds to the level of returns. That is, higher risk can translate to greater returns. Of course, it also means a bigger chance for loss. Determining the amount of risk you should take on is a unique decision, but there are common factors to consider. Ask yourself how long you are willing to keep your assets tied up in the mutual fund. Low-risk investments are more likely to yield conservative returns over the long run, which would work well if you are seeking long-term capital gains. High-risk investments are more volatile and rely on a shorter time frame, but if they are successful, they produce high-yield returns. This strategy may be more appropriate if you’re going after immediate income. Wherever you fall on the risk-return spectrum, there will be a mutual fund for you. When considering these funds, just make sure to take a good look at each one’s risk/reward profile.
Types of funds
There are several tiers of mutual fund classification. At the most basic level, there are three main types, divided by the type of assets they manage: equity funds, fixed-income funds and money market funds. Equity funds invest in stocks. As they make up most of the mutual fund market, there is a wide variety of equity funds. They differ in size and style, ranging from small to large funds that focus on finding undervalued companies, growing with established companies, or investing in a blend of the two.
As the name implies, fixed-income funds provide a steady stream of income. They are also called bond funds and are mainly invested in government or large corporate debt. They provide a consistent, conservative return for investors.
Finally, money market funds have little risk because you hold on to your principal. However, this also means money market funds will not provide spectacular returns. Treasury bills are the most marketable security in this group.
Other types of funds to consider are global funds for international investments, socially-responsible funds, which only invest in companies who meet a certain ethical standard, or sector funds that focus on specific sectors of the economy like agriculture or healthcare. Whatever asset you may settle on, one type of fund you always want is the “no-load” — a fund in which shares are sold without a commission fee.
Finding the right mutual fund. With thousands of funds to choose from, it would be impossible to collect the pertinent data for all of them yourself. Luckily, there are companies dedicated to producing digestible mutual fund reports.
These reports provide all the data you need to evaluate the quality of a fund. Two companies that provide this service are Morningstar and Value Line. Many public libraries grant access to Morningstar Mutual Funds, which means you can read these reports for free. All this research may seem like a lot of work, but it’s always better to invest time before investing your money.