Mutual funds can be a great option for those that are looking to invest their money but are not willing or able to research each stock in their portfolio on a regular basis. However, choosing a good mutual fund can be challenging. There are thousands of mutual funds in existence, and no one fund is created equally. Finding the right fund for you, and your investment goals could take some time. How do you choose a mutual fund? We will cover that process in greater detail below.
What is a Mutual Fund
Taking a step back, let’s first review what a mutual fund even is. In its most simplest form, a mutual fund is a professionally managed investment vehicle. This investment vehicle has numerous investors, and each investor continues their own amount of money to the overall fund. The fund itself invests in various underlying securities, including stocks, and allocates a specific amount of money to each underlying investment.
Although a mutual fund has numerous investors, each investor isn’t entitled to the same profit gains or losses from a pure dollar standpoint. For example, if investor A contributes $100,000 to the fund and the fund increases 8%, investor A generated $8,000 in profit before paying fees. If investor B contributed $10,000 to the fund and the fund rose 8%, investor B would make $800 before paying fees.
Why Use a Mutual Fund
A good mutual fund is a common option for many investors, and there are numerous reasons why.
- First and foremost, a mutual fund is professionally managed. One would like to believe professional money managers can generate a greater return than people who passively manage their money
- Secondly, time and convenience play a major role in why one would invest with a good mutual fund. It could take hours each week to read up on your investments, and some people just don’t have that time.
- Thirdly, there is a skill gap. In a similar vein to points 1 and 2 above, plenty of people don’t know how to invest or what to look for in investments. Perhaps they make their living in a completely different profession. Instead of taking on the risk themselves, they wish to rely on the professionals.
Choosing a Mutual Fund
If you know you want to invest in a good mutual fund, following the below steps can help ensure you are investing in a fund that fits your needs and desires, and that you are investing in the best mutual funds possible.
Review the Funds Performance
A mutual fund will always publish its average rate of return for a trailing period – typically since the fund was created. Compare the average fund performance against the performance of the general stock market, such as the S&P 500. Ideally, the mutual fund generates a greater rate of return than the general stock market. If not, investing in an ETF such as the SPY might be your best option.
Review the Funds Management Team
In addition to reviewing the fund’s performance, review the fund’s management team. Where did the people who will be managing your money go to school? What accomplishments do they have? Where were they employed before joining this fund, and how was their performance at their previous fund? All of these questions can be found, even though it may take a bit of digging. With that said, these questions and answers are worth looking into!
Review the Assets in the Fund
If the fund has a solid trailing performance and a strong management team, it’s now time to look at the underlying assets of the fund. If you don’t know about investments or asset classes, this part can be challenging. But all mutual funds will post what percentage of their money is allocated to specific assets, such as stocks. Look to see if you like the companies the fund is investing it – not only from a consumer standpoint but also from an investor’s perspective.
Do Your Own Research
Following the above bullet, do your own research on the underlying assets and the mutual fund itself. Look to see if you agree with the fund’s investment decisions, and look to see if there is any bad press on the fund, or on any of the managers.
Understand the Funds Fees
Considering the fact that mutual funds are professionally managed, they often come with fees. You must fully understand all of these fees before making an investment decision. Even if the mutual fund generates a greater return than the overall market at face value, you must back out the fees to ensure the rate of return is still superior after you pay that expense. The fees are not a one-size-fits-all matter. Each fund will have its own fees and fee percentages.
Select Your Time Horizon
Mutual funds typically allow you to select your own time horizon. For example, if you are 30 years old and want to retire at 70, you may be inclined to go with a more aggressive fund. If you are approaching retirement, it may be wise to go with a more conservative mutual fund.
Is a Mutual Fund Right For You
Mutual funds are a great option for many people. If you invest in a good mutual fund, a professional will manage your investments, and the fund may generate a strong rate of return. However, mutual funds have fees that must be taken into consideration. Before making any investment decision, consult with a financial advisor. Financial advisors can help you budget, prioritize debt repayment, and can help you identify which investments are best suited for you and your goals.