How to Choose a Mutual Fund
Pick and Buy a Mutual Fund for the Small Investor
Investing Goals, Performance, Index Funds, Stock Funds
Small investors should choose a mutual fund by deciding what kind of investments they want to hold. Then they should choose a mutual fund by its investment goals. Generally, the typical investor should should choose a large mutual fund operated by one of the major fund management companies. Next, they should review the portfolio of the mutual fund and its expense fees before they choose a mutual fund. Many small investors choose an Index Fund instead of other mutual funds or in addition to them. The following tells you, in more detail, how to choose a mutual fund.
For most investors, particularly small investors with a modest amount to invest, a mutual fund is an excellent investment choice. Here are the advantages when you choose a mutual fund instead individual stocks. Each of these advantages will be explained below.
- the convenience of choosing a mutual fund
- the better diversification of investments
- the reduced risk and cost
- the availability of Index Funds
- the cost savings of ETFs, Exchange Traded Funds
- and the opportunity to target investing sectors.
- Why You Should Choose a Mutual Fund
- Advantages of Choosing a Mutual Fund
- How to Choose a Mutual Fund
- Choose a Mutual Fund by Its Investments
- Choose Mutual Funds to Track Major Stock Indexes
- Choose a Mutual Fund by Its Investment Goals
- Choose an Open-Ended Mutual Fund
- Choose One of the Major Mutual Funds
- Choose An Exchange Traded Fund, a New Type of Mutual Fund
- A Unit Investment Trust Is Different from a Mutual Fund
- A Hedge Fund Is Not a Regulated Mutual Fund
Why You Should Choose a Mutual Fund
When you choose a mutual funds you are choosing an investment company. The mutual fund company combines your money with that of other investors to buy stocks, bonds or other securities. Managers of the mutual fund use the money to buy investments that match the goals of the mutual fund. The fund manager determines which investments to buy for the fund, and keeps track of the value of the mutual fund. When you choose a mutual fund, you buy shares in the fund. Buying shares in a mutual fund means you own part of a basket of securities. By choosing to buy shares in a mutual fund instead of buying individual stocks, you invest in a variety of different stocks. The more stocks you own, the lower your financial risk if one company fails. When you choose a mutual fund, you can diversify your investment and reduce your risk.
Advantages of Choosing Mutual Fund
Choosing a mutual fund makes investing easier. That's the main advantage of mutual funds. Investing is difficult when you try to pick stocks on your own. You need time, training, and up-to-date information. For many investors, the amount of financial news and advice is confusing. Choosing a mutual fund makes it easier to own a diversified group of stocks. In order to diversify your investment, it takes a lot of capital to buy a variety of individual stocks.
When you choose a mutual fund, you can start investing without much money. Many mutual funds will accept new accounts with an initial investment of $500 or $1000. For these reasons, choosing mutual funds is an excellent plan for the average person who wants to invest for retirement, college or other financial goals.
Despite periodic fluctuations, choosing a mutual fund over the long-term pays you better than your savings account, Certificates of Deposit, U.S. Treasury bills, notes and bonds, or money market accounts.
How to Choose a Mutual Fund
To choose a mutual fund, pay attention to how much the fund earns each year. All mutual funds must report their average annual compounded rates of return for 1-year, 5-year and 10-year periods. This is called the average annual total return for the fund. It is one criterion for choosing a mutual fund.
There is some concern that professional mutual fund managers do not outperform Index Funds and do not outperform other investors. The Wall Street Journal reports that separately managed accounts did better than mutual funds in 22 of 25 categories from 2006 to 2008. Morningstar, Inc said that separately managed accounts outperformed mutual funds in 25 of 36 stock and bond market categories.
Do NOT choose a mutual fund just because it has a low share price, because mutual fund prices vary depending on how many shares are outstanding.
Choose a Mutual Fund by Its Investments
Mutual funds are classified by the type of investment securities they hold. The most common securities purchased by a mutual fund are money market instruments, stocks, bonds, or shares of other mutual funds. For example, a stock mutual fund holds stocks. Some mutual funds invest in more exotic instruments such as senior loans and derivatives like forwards, futures, options and swaps. A mutual fund can invest in United States securities or international securities. The prospectus of the mutual fund will explain its investment policy.
Mutual funds that invest in bonds are called bond funds. Your earnings and the risk you carry are determined by what type of bonds the fund holds. They might hold high-yield junk bonds or investment-grade corporate bonds. They could invest in the bonds of government agencies, corporations, or municipal bonds. They can hold bonds with a short-term or long-term maturity.
Choose Mutual Funds toTrack Major Stock Indexes
Small investors often choose mutual funds. Some mutual funds are called Index Funds An Index Fund is a mutual fund that will match the investment performance of a major stock market index, like the S&P500, the Dow, the Russell 5000 and the NASDAQ 100. The Index Fund owns a basket of stocks that precisely match the stocks in the index. An S&P500 Index Fund will own the securities, and possibly index futures, to match the performance of the S&P500 Stock Index.
Many small investors choose one or more Index Funds, instead of researching individual mutual funds. When you choose an index fund, your investment will perform as well as the index, no better and no worse. The fees to manage an index fund are lower than other mutual funds because an index fund is a passive fund which needs little management. A new investor is often well-advised to buy shares in an index fund. Vanguard, a well-known investment firm, manages many index funds.
Choose a Mutual Fund by Its Investment Goals
Choose a mutual fund by its investment goals.. The investment goal is also called its investment objective or focus of interest. You'll find mutual funds with goals for capital appreciation, growth, capital preservation, large-cap, mid-cap, small-cap, emerging growth and international investment. Growth funds invest in the stocks of companies that have the potential for large capital gains. Value funds look for stocks that are undervalued. Some mutual funds invest in a particular industry or sector of the economy, like a technology fund, or a gold fund.
Choose a mutual fund that owns gold stocks and other investments, if you are optimistic about the price of gold. Choose a mutual fund that invests in technology if you expect the technology stock sector to do well.
Choose a mutual fund that is an Index Fund, if you want to invest in the large group of stocks in the index.
Before you choose a mutual fund, look at the current fund portfolio to see if its investments are right for you.
Whether actively managed or passively indexed, mutual funds have risks. If the fund invests primarily in stocks, it is usually subject to the same ups and downs and risks as the stock market as a whole.
Choose an Open-Ended Mutual Fund
Mutual funds are organized as either open-end funds or closed-end funds. Most mutual funds are open-end funds. These funds issue new shares and redeem shares every day. They have no limit on the amount of shares in the fund or the size of the fund. An open-end fund continues to grow by attracting more investor capital. Most investors should choose an open-end mutual fund.
Closed-end mutual funds are organized with a fixed number of shares. Their shares trade on a stock exchange, where you can buy them. The trading price of the shares does not always reflect the value of the assets it owns.
Choose One of the Major Mutual Funds
Most investors should choose one of the major mutual funds.
There are many major investment companies that each offer a large family of mutual funds. Some of these companies are American Century, Dreyfus, Fidelity, Franklin Templeton, Goldman Sachs, Invesco, Janus, TIAA-CREF, T. Rowe Price, and Vanguard. You can buy shares in a mutual fund by contacting the fund online or through a stock broker. You can contact the mutual fund directly for a fund prospectus and account application. Brokers like Schwab, TD Ameritrade and E-Trade also sell shares in mutual funds.
An Exchange Traded Fund Is a New Type of Mutual Fund
You can also choose an Exchange Traded Fund. An Exchange Traded Fund, an ETF, is a mutual fund. However, its shares trade directly on a stock exchange. The share price of an ETF reflects the value of its assets. The large ETFs track stock indexes like the S&P500 or the Nasdaq Composite Index. ETFs are more efficient than choosing traditional mutual funds. ETFs have lower expenses than a mutual fund because the mutual fund must keep buying and selling securities.
A Unit Investment Trust Is Different from a Mutual Fund
Unit Investment Trusts are trusts, not mutual funds. The Unit Investment Trust issues an undivided interest in specific securities. The shares of a Unit Investment Trust are not an interest in a basket of investments, but in a specific asset. A real estate trust is an example of a Unit Investment Trust.
A Hedge Fund Is Not a Regulated Mutual Fund
A hedge fund is not a regulated mutual fund. Hedge funds are private pooled investment funds. A hedge fund seeks high returns by taking more risk and may also borrow more money to invest. Hedge funds often charge a management fee of 1% or more, plus a performance fee of 20% of the hedge fund's profit. Most investors should choose a mutual fund, rather than a hedge fund for investing.
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