Mutual Funds 101

Choosing the Best Mutual Funds

A mutual fund is an investment in multiple securities. A single share of a mutual fund is like a tiny investment in hundreds – or even thousands – of stocks and bonds. The benefit of a mutual fund is that it allows a small investor to invest in a more diverse array of securities than he would be able to invest in otherwise. With as little as $500, for example, an investor can buy an index fund that invests in 500 different stocks. Individually, these stocks would cost tens of thousands of dollars.

Mutual funds, however, charge fees that can make them poor investments for smaller investors. For this reason it is critical to choose funds wisely.

The Best Mutual Funds: Defining Characteristics

There is no “best mutual fund.” But there are certain characteristics you should look out for:

  1. Low Fees – Front-end loads, 12b-1 fees and Management fees can significantly decrease returns on your investment. For example, a fund with a 5.75% front end load will need to return 6.1% just to break even. Performance varies; fees are constant. So, while it may seem like a good idea to invest in the best-performing fund over the last three years, a fund with lower expenses will likely be a better investment.
  2. Experienced and committed management – A fund with a new manager is a double-edged sword. Sure, the inexperienced manager wants to impress with high-flying numbers and may deliver, but there is no track record to check on the manager’s capabilities. Managers that have been with their funds for over five years have proven their mettle . Even more important, it is important for management to be invested in the fund, so as to align their interests with shareholder interest.
  3. Above average performance – All too often investors purchase the funds that have performed best over the last one- or three-year periods. This is called “chasing performance.”

    It doesn’t work.

    What does work is finding those funds which consistently outperform their peers – funds that have higher returns than similar funds that invest in the same type of securities.

The Right Fund for Your Needs

When starting out, it is important to choose mutual funds that invest in a wide array of securities. As your portfolio grows, niche mutual funds should become part of your portfolio. Some funds invest only in Chinese securities, others are specifically geared toward investments in India. Eventually, your portfolio will include both, with larger amounts in U.S. Equities and larger companies with more stable growth prospects.

It is important to focus on the more stable niches of the world economy. Consider the following as a good general rule in order of importance when your portfolio grows beyond $10,000:

Any portfolio over $10,000 should include all of these in varying degrees, the more stable asset classes in a larger percentage.

Your First Mutual Fund

Your first mutual fund should include as many asset classes as possible, and the lowest expenses available for its asset class. A good U.S. Large Cap index fund will provide low fees and stability for a beginning investor.

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