Mutual funds are portfolios of bonds, stocks, and other investments that are managed by professionals. The funding for mutual funds comes from people who are willing to pool their resources to get access to a wider range of investments than what they can get on their own. In practice, this means interested individuals buy shares in mutual funds, which represent portions of the investments held by those same mutual funds. This investment vehicle can be a powerful investing tool, so long as individuals know what they are doing.
Figure Out Your Investing Goal
If you are interested in mutual funds, start by figuring out what you want from your mutual fund investment. One person might want to increase their current income, while another person might want to maximize the value of their investments in the long run. Likewise, there are plenty of people who invest to fund a future cost, such as higher education. Keep in mind the goal for your mutual fund investment is not necessarily the same as the goal for your investment portfolio.
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Figure Out Your Risk Tolerance
Whether you are investing in mutual funds or some other kind of investment, you can expect a trade-off between return and risk. Return is what investors can expect from the investment, while the risk is the chance that the return won't be what investors expect. If you want to invest in mutual funds in a calm, confident manner, find the combination of return and risk that is right for you. Otherwise, you may find yourself fearful or frustrated because of your mutual fund investment, which is not a good mind-set for investing success.
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Figure Out Your Investment Horizon
Your investment horizon is the period of time for which you are expecting to hold on to your investment. This can have a wide range of consequences when you choose to invest in mutual funds. For example, if you have a short investment horizon, you need to remember that mutual funds have sales charges you must factor into your calculations. Likewise, if you have a short investment horizon, you are going to have a smaller amount of available funds to work with. This means a stricter limit on what you can and can't achieve through your investing. Generally speaking, if you want to succeed at mutual fund investing, you should have an investment horizon of at least five years.
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Figure Out the Kind of Investments You Want to See in Your Mutual Fund
At this point, you should have a general idea of what kind of investments you want to see in your mutual fund. For example, if you are someone with a fair amount of risk tolerance as well as a long investment horizon, you might be interested in a long-term capital appreciation fund that has a higher percentage of stocks relative to other kinds of investments. In contrast, if you just want as much quick income as you can get, the obvious choice is an income fund packed full of both corporate and governmental bonds.
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Consider the Expected Return of a Mutual Fund
The return of a mutual fund tends to be one of the most important factors for mutual fund investors. Generally speaking, people get a general idea of what a mutual fund's return will be by looking at its returns in the past. However, it is important to remember that this will produce a rough estimate rather than a guaranteed number for what the return will be. Fluctuations in the economy are not overly predictable.
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Consider the Expected Cost of a Mutual Fund
Figuring out the expected cost of a mutual fund tends to be much easier because it should be included in its marketing information. However, the range of mutual funds that exist often complicate this process; there are various ways to charge mutual fund investors. For example, both front-end loaded funds and back-end loaded funds charge a set percentage of the investment. The difference is that the first charges a set percentage of the initial investment; the second charges a set percentage of the proceeds when the investor sells the shares. Most mutual funds will charge between 3 and 6 percent, but some go much higher. There are no-load funds as well, but they tend to have a high administration fee as well as other charges to make up for the lack of a set percentage charge.
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Consider the Size of the Mutual Fund
In most cases, the size of a mutual fund shouldn't be too much of a concern. However, there have been examples of mutual funds so big that their managers struggle to run them effectively and efficiently. Furthermore, the size of a mutual fund can influence the strategies of its managers, which can alienate mutual fund investors who preferred the previous investing approach.
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Be Cautious about Expected Returns
Be cautious about putting too much trust in previous returns; what was true in the past might not remain so in the future. Studies suggest most managers aren't capable of ensuring consistent returns year after year. Of course, this is unsurprising considering the inherent risk of most investments. As a result, you might not want to invest in a mutual fund just because it has been having high returns for a while. Downswings often follow upswings in the world of investing.
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Look At Other Factors of Relevance
It can be worthwhile to look at factors of relevance besides past returns to get a better idea of how a mutual fund might perform. For example, study the people in charge of a mutual fund; gauge their level of professionalism as well as other factors that can impact their performance. Likewise, look at informative ratios and measurements such as the management expense ratio. This is the percentage of the mutual fund's investment that is being used to cover its expenses. Such measurements can help you get a better perspective on what is going on. One example: a higher management expense ratio means a lower return for you and the other mutual fund investors.
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Check Mutual Fund Strategies
There is no sure-fire method for becoming a successful mutual fund investor. However, some strategies have become popular over time, and are worth checking out. One is momentum investing or investing with the intent of benefiting from existing trends. Luckily, momentum investing with mutual funds is as simple as choosing one with a manager who mentions momentum as one of their criteria for choosing investments. Another example is contrarian investing. This entails going against existing trends because of the tendencies of the market to overdo things. You can engage in contrarian investing by either choosing contrarian-style funds or choosing funds specializing in sectors you believe are under-valued.
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