What Exactly Is A Mutual Fund?
Mutual funds are perfect for investors who have the resources and desire to see their money put to work but don’t necessarily have the time to research and pick their own stocks.
This is because with one single purchase you gain access to a diversified portfolio of different companies. Mutual funds are effectively just ‘pools’ into which individual investors choose to share their resources. By clubbing together to form a larger unit, all can access a wider range of investments than would be feasible as isolated individuals.
As such, with your money invested in a mutual fund you are much less exposed to the risk of a single stock tanking and can potentially benefit from over-all trends affecting the market in a positive way.
How to Start Thinking About Which Fund is Right for You
Mutual funds come in all sorts of different styles. Pretty much every sector of the stock market universe will have several funds competing to provide the best coverage, and each fund will have its own investment philosophy guiding buying and selling decisions.
For example, there are funds tracking only large-cap firms in the US, the UK or elsewhere; equally there are numerous funds that specialise in finding the next small companies who are about to soar in value. Then there are funds hunting for high dividend payers, both within single countries and across the globe. There are even funds tracking specific sectors, be it infrastructure, or consumer discretionary goods, or financial services, or any other sector or sub-sector you could ever think of.
As such, if you think mutual funds might be the best place for you to park your savings, the next step is to start considering what type of fund would suit your needs best.
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Who’s the Boss?
Mutual funds are actively managed. This means that there is a fund manager, supported by a team of researchers and analysts, who is actively picking stocks to include in the portfolio. They will also be making decisions about what quantity and when to buy or sell, and how to balance the portfolio so that no single company or even sector is overrepresented.
Whilst this means you should face considerably less risk than comes from owning individual stocks, it also means you are putting a great deal of trust and responsibility in the manager to make the right calls.
As such, the first thing you want to do is to check out who is managing any fund you are interested in. What is their personal investment philosophy? How have they performed over recent years? How many years of experience do they have, and where did they work before their current job?
Whilst there isn’t ever going to be a ‘perfect’ manager who ticks all the boxes, you will immediately get a sense of whether you approve of a manager’s approach if you look into their background and approach by answering the questions above.
What Are the Fees Like?
Next up, although of course for some people this could well have been the first thing they would consider, is how much will accessing this fund cost you.
Keeping investment costs low is vitally important – management fees will eat away at growth over time. If you can keep your fees relatively low, you are giving your investments a much better chance to grow over time.
However, cheaper does not always mean better! This is true of (almost) every purchase you will ever make, and it is especially true for investing. As such, costs need to be considered alongside other factors; most notably how well the fund can be expected to perform. Many would consider it worth paying a little extra to access a top fund manager with a great track-record and clear and successful investment strategy.
Finally, be wary that fees can sometimes be overly complicated. Make sure you check the prospectus in detail before investing in any fund. Some funds charge a flat annual fee, others may have a performance-adjusted fee depending on how the assets have performed. Many will also charge an entry and exit fees when you want to move money in or out of the fund. Read the small print before committing your money to a fund!
Your Investment Objective and Time Frame
Last but not least, prospective investors need to be aware of what they are saving for, and when they want to get their (hopefully increased!) money back.
If you are saving for the long run and don’t expect to withdraw for 20, 25 or even 30 years then you can afford to be a bit more aggressive. By this we mean to go for slightly riskier stocks which have more potential for growth, rather than staid old stocks or even bonds that have limited probability to move either up or down.
On the other hand, if you are investing but expect to retrieve the money in 5 years or less, you should seriously consider a much more risk averse approach. Remember that a single recession or financial shock could wipe out a great deal of your hard-earned gains in a very short space of time.
A Few Things to Avoid…
This introduction will end by pointing out a few easy to overlook problems that could impact you when picking a mutual fund. Our view is that by considering all of the factors explained in this article, you should be in a good place to pick one or even several mutual funds to meet your individual investment needs.
It can’t be emphasised enough that you need to stay diverse! Avoid like the plague any fund that is too focused on one sector or one asset type. The whole point of mutual funds is to enable you to access a wider range of investments that would be practical as an individual – don’t throw away this advantage by picking a fund too concentrated on one area. If this sector starts to struggle, the value of the whole fund will be dragged down.
Finally, don’t fall for the trap of thinking that past returns will always be a good indictor of future performance. Many investment fortunes have been lost in this way before, and many more will be in the future. If a fund has seen stellar performance over the last year, but was struggling before that, dig into the data a little. Why did things turn around 12 months ago? Was it due to a short-term factor? How would you expect this fund perform if another recession moved into view?
Ultimately, there is no level of research that can fully guard against loss, but if you consider all of the factors above, you should be in a good place to start picking mutual funds for your investment portfolio.
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