Mutual funds are not for everyone. I personally did not start using mutual funds to invest until I started my 401k. I was more than comfortable choosing my own stocks and taking the risks that come along with that. However, as I had less and less time to devote to researching stocks, I found that buying a pre-made portfolio was more efficient. And if you choose the right mutual funds, it can be cost effective as well. There are a few things to consider when choosing a mutual fund.
What is a Mutual Fund?
A mutual fund is a managed portfolio of assets. For this post, we are going to assume that the assets are stocks. However, there are portfolios of bonds, stocks, other funds, etc. Check out my video that explains Mutual Funds versus ETFs for more. You can also visit Standard Life for more information on choosing a mutual fund.
How to Choose a Mutual Fund
The first thing you need to think about when choosing a mutual fund is what type of assets do you want to buy. We are assuming stocks, but even within stocks as a whole there are different types. Do you want stocks that pay dividends and a mutual fund that pays those dividends as well? Do you want a mutual fund with small companies that may benefit from merger activity? Do you want a fund with a mixture of the two? The size of the company will be a consideration. Another factor to consider is the trade off between value and growth. Do you prefer stocks that are cheap and may bounce back to fairly valued or would you rather stocks that may look expensive now but have high growth prospects. Are you confused already? Maybe you would rather someone choose investments for you. Either way, you will pay a fee. And that is the final factor to consider.
Mutual funds are portfolios run by managers who are compensated for their service. Some mutual funds have higher fees than others and it is important to look at these fees. A recent report on Frontline called The Retirement Gamble revealed that many employees do not check for fees and options in their employer’s 401k plan and therefore have no idea what they are paying to invest. The fee information can be found in the mutual fund prospectus. The expense ratio of a mutual fund includes the fees required to operate the mutual fund. This percentage comes out of your return each year. For example, if the fund returns 3% for the year and the expense ratio is 1.5%, you are only getting 1.5%. Keep in mind that this fee does not include brokerage commissions or sales loads. If fees bother you, look for no-load, low fee funds.
How did you choose your mutual funds?