How to choose the best mutual funds: 7 essential tips for investors
There are thousands of mutual funds in the market at any one time. So how do you choose exactly? Although it might seem difficult, it is not necessary if you are following the right process.
Mutual funds allow groups of investors to pool their money. A fund manager then selects the investments that match the fund’s investment strategy. As a result, individual investors who buy shares of the fund are actually investing in the assets selected by the fund manager. For this reason, it is vitally important to find a mutual fund whose objectives match yours.
Here are seven tips to help you select the best mutual funds for your needs.
1. Consider your investment objectives and risk tolerance
With so many mutual funds available, it’s inevitable that many of them won’t be suitable. A mutual fund can be popular, but that doesn’t necessarily mean it’s the right one for you. For example, do you want your money to grow steadily over time with a low level of risk? Do you want the highest potential returns? These are questions you will need to answer yourself.
You should also consider your risk tolerance. For example, are you prepared to tolerate large fluctuations in the value of your portfolio for the chance to achieve better long-term returns? If you are investing for retirement, it is usually best to keep your money invested for the long term.
But if a very aggressive strategy makes you cold-hearted and sell your investments, it’s best to adjust your strategy to something more suited to your risk tolerance. After all, selling your investments can also lead to a lack of return. In addition, you can realize capital gains depending on the type of investment account.
Your time horizon is also important. If you need to access your money in less than five years, a dynamic growth fund is probably not the best strategy. An example of a fund whose time horizon is already integrated is a target date fund, which adjusts its risk level according to the proximity of retirement age.
2. Know the fund’s management style: is it active or passive?
Another way that mutual funds can vary is their management style. One of the biggest contrasts can be seen when comparing active and passive funds. With actively managed funds, the fund manager buys and sells securities, often with the aim of beating a benchmark, such as the S&P 500 or Russell 2000. Fund managers spend many hours researching companies and their companies. fundamentals, economic trends and other factors in order to achieve better performance.
The trade-off with actively managed funds is that fees can be high to compensate fund managers for their time. Are these fees worth paying? It may seem difficult to answer, but if you consider the past performance of the fund relative to the market, it may provide some perspective. You should also see how volatile the fund has been in addition to its turnover.
3. Understand the differences between types of funds
While there are thousands of different mutual funds, there aren’t that many types of funds. There are a handful of different types of mutual funds that generally correspond to different investment goals and objectives. Here are some examples:
- Large cap funds. These funds invest in large, widely owned companies with a market capitalization typically worth $ 10 billion or more.
- Small cap funds. These funds tend to invest in companies with market capitalizations between $ 300 million and $ 2 billion.
- Value Fund. Value funds are made up of stocks that are perceived to be undervalued. They are generally well established companies, but are considered to be trading at a discount. These companies may well have a low price-to-earnings ratio.
- Growth funds. Growth funds invest largely in companies that are growing rapidly and whose primary objective tends to be capital appreciation. They may have a high price-to-earnings ratio and have greater potential for long-term capital appreciation.
- Income Fund. Some funds pay regular income. This can take the form of a dividend or an interest, such as with dividend stocks and bond funds.
4. Watch out for high fees
It is important to be aware of fees, as they can have a huge impact on the return on your investments. Some funds have an up-front load fee, charged when you buy stocks, and some have back-end load fees, charged when you sell your stocks. The other funds are no-load funds; as you might expect, these funds have no load fees.
But loading charges aren’t the only type of charge. The other expense that is getting a lot of attention is the expense ratio. These fees are generally billed annually as a percentage of assets under management. So, if you invested $ 100 in a mutual fund and it has an expense ratio of 1%, you will be charged a dollar a year. With the advent of index funds and increased competition, we are starting to see mutual funds that also do not have an expense ratio.
According to a recent report by the Investment Company Institute, the average expense ratio of actively managed funds was 0.71% in 2020. The same report showed that the average for index funds was 0.06%. While 0.71% doesn’t seem like a high number, if you plug them into a mutual fund expense calculator, you will find that it can cost tens of thousands of dollars over a lifetime.
5. Do your research and assess past performance
It is important to do your research before investing your hard earned money in a mutual fund. In addition to determining whether a fund meets your investment objectives, you should also assess the overall quality of the fund.
For example, does the fund have a strong management team with a long history of success? The top performing funds have created a well-oiled machine that doesn’t necessarily rely on one person to keep running smoothly. In the tech world, this is akin to the concept of redundancy, where failure of one part will not reduce the entire system.
It is also important to watch out for high turnover rates. This happens when the fund manager frequently buys and sells securities. The main reason this is a problem is that it creates taxable events. This is not a problem if your funds are held in a tax-advantaged account, such as a 401 (k) or an IRA. But for taxable accounts, high levels of turnover could significantly hurt your returns.
These questions will put the overall performance of the fund in context. Also check the historical performance of the fund. Has it generally exceeded its benchmark? Is the fund unusually volatile? This will help you know what to expect if you decide to invest.
6. Don’t forget to diversify your portfolio
Maintaining the diversity of your portfolio is one of the most effective ways to ensure long-term performance and stability. This is one of the main reasons for the attractiveness of total stock funds, which own tiny shares of every publicly traded company. Sometimes there are crises that can affect an entire industry, so invest in all industry helps mitigate this risk.
You can also choose to invest in international funds, bonds, real estate, fixed income funds, and many other types of assets. All of these can create a more complete portfolio with lower volatility.
7. Stay focused on long-term growth
Yes, you can lose money in mutual funds. As the saying goes, “past performance is no guarantee of future results”. It is precisely for this reason that you should do your research and consider meeting with a financial advisor if appropriate.
That said, if you do your due diligence and maintain a well-balanced and diversified portfolio, you can be confident in its potential to grow over time. As we can see with the past 100 years of performance of the Dow Jones Industrial Average (DJIA), the index has trended upward throughout its history. The longest downturn was from around 1966 to 1982. Although this was a long time, the DJIA rebounded strongly, increasing steadily for the next 17 years.
This illustrates the importance of investing for the long term. While you can certainly lose money in a mutual fund, investing in funds with strong historical performance and experienced fund managers will help you minimize risk in the short term and maximize your chances of long term growth. term.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past performance of investment products does not guarantee future price appreciation.