If you are thinking about investing in mutual funds, but aren’t sure how to go about selecting one, our guide about mutual funds is here for you.
A mutual fund happens to be an investment vehicle that is created from a pool funds collected from various investors, like money market instruments, stocks, bonds, and other similar assets. A mutual fund is operated by a money manager, who invests the capital and attempts to make capital gains.
The main advantage of a mutual fund is that it gives small investors access to a professionally managed and diversified portfolio of equities, bonds, and other types of securities, which would be impossible with a small amount of capital. Every shareholder proportionally participates in the loss or gain of the fund. A mutual fund unit or share can be redeemed or purchased as needed at the current net asset value per share, which is often called NAVPS.
Identify risk tolerance and goals
Before you purchase shares in any type of funds, you need to identify your goals and desires for the money that you are investing. Are you looking for long-term capital gains? Will you be using the money to pay for college expenses or as a supplement for retirement? Identifying a goal is vital because it will let you shorten the list of more than 8000 mutual funds that are in the public domain.
Additionally, you will also need to consider risk tolerance. Are you able to afford and accept the dramatic swings in your portfolio value? Or are you wanting a more conservative investment? Being able to identify risk tolerance is just as vital as identifying a goal. Besides, what good is an investment if you have trouble sleeping at night because of it?
Lastly, there is the issue of time horizon that needs to be addressed. You need to think about how long you can have your money tied up, or if you anticipate any liquidity concerns in your near future. This is often an issue because mutual funds could have large sale fees.
Determine your mutual fund type
If you plan to use the money in a long-term period and are willing to assume a decent amount of volatility and risk, then you should opt for a long-term capital appreciation fund. It is these types of funds that normally have a high percentage of assets in common stocks and are considered to be volatile. They also have a potential for large rewards over time.
If you are in need of money right now, then you need to have shares in an income fund.
But there will be times when you have a long-term goal in mind, but are unable or unwilling to assume a large risk. In this case, you would need a balanced fund which invests in bonds and stocks.
Learn about the mutual fund fees
A mutual fund can make money by charging fees. It is vital that you have an understanding of these types of fees that you could face when buying into an investment.
There are some funds that will charge a sales fee which is also called a load fee. It occurs when you invest for the first time, or when you sell the investment. Front-end load fees are paid out of the first investment, while back-end load fees are charged when you sell your investment.
Both back-end and front-end load funds will normally charge between 3% and 6% of the total amount that was invested or distributed, but by law this can be as high as 8.5%. The purpose is to discourage turnover as well as to cover the administrative charges that are associated with this investment.
There are still other funds that will charge the 12b-1 fees, which are put into the share price and are then used by the fund for sales, promotions, and other types of activities that are related to the distribution of shares. These types of fees may be straightforward and done at a predetermined time, or you may not even be aware of the fee at all. The 12b-1 fees can be up to 0.75% of the average assets yearly.
Do your research
Just like with all sorts of investments, you should research the past results and ask these questions:
- Was there an unusually high turnover, which resulted in larger tax liabilities for said investor?
- Did the fund manager deliver results that were consistent with general market returns?
- Was the fund more volatile than big indexes?
With that in mind, the past performances do not guarantee any future results. So before you buy into a fund, review the company’s site and look for any data about anticipated trends. A candid fund manager will give you a sense of what is going on with the fund as well as talk about any trends that will be helpful.
Consider the fund size
Normally, the fund size doesn’t hinder the ability to meet the investment objectives. Although, there will be times when a fund gets too big.
So how big is too big? There aren’t any benchmarks that have been set in stone, but $100 billion can really make it hard for a fund manager to operate the shares efficiently. It also makes the process of buying and selling stocks with anonymity impossible.
Picking the right mutual fund could seem to be a pretty hard task, but knowing your goals and objectives is already half of the battle done. If you follow these tips when selecting a fund, you will increase your chances of success.
Was our guide helpful to you? Feel free to ask your questions in the comments below and check out our post about mutual funds for beginners.
Need more advice? Don’t hesitate to check out our complete guide to investing into stocks and bonds and learn how to anticipate market movements and navigate the trading field.