What to Look For When Choosing Mutual Funds
Odd as it may sound, choosing funds can be easier than choosing individual investments. Every fund states its goal - called its investment objective - and how it plans to meet it. The plan is its investment strategy and the way it puts that strategy into action is its investment style. When choosing a mutual fund, take a look at the fund's prospectus to compare the fund's investment objectives with your own goals. Remember that the fund has a plan and an objective, but not a guarantee. The fund may not meet or maintain its objective.
Although most mutual funds concentrate on just one asset class - stocks, bonds, or cash - there are funds that contain all three asset classes for investors who don't want to own more than one fund or create their own asset allocations. There is a lot of variety within each asset class: large-, medium-, and small-company stock funds, and funds that own stock in companies of all sizes. Some stock funds concentrate on growth or even faster growth. Some concentrate on what they call value. There are some that buy dividend-paying stocks intending to provide income, or a combination of growth and income. You get the idea.
The same is true of bond funds, which may zero in on particular issuers, particular terms, or a particular level of risk. Ditto on money market funds which invest in cash equivalents - mostly very short-term bonds.
Each of these asset classes comes with its own set of unique risks. You should make sure you consider and understand these risks. Check out the fund's prospectus for more information regarding the risk that accompanies the assets in the fund, and weigh that carefully when making your investment decision.
Whether you're looking for a fund to fill a specific hole in your portfolio or for several funds to build a portfolio from, seek, and chances are you'll find it.
Before you invest in mutual funds, check out the fees, which are subtracted before return is calculated or distributions paid. You can find details about these fees in a fund's prospectus, along with its expense ratio. It shows what you'll pay every year, expressed as a percentage of your total investment in the fund.
Some funds have higher expense ratios than others. 0% is as low as it goes. 2% is high. And some fees aren't included, like transaction costs. The more often a fund manager buys and sells investments, the higher the transaction costs can be.
Some funds also charge a penalty fee to discourage you from trading in and out of a fund quickly. You can avoid those by waiting the required time before you sell - often 90 days. Check to be sure. There may be other avoidable fees, too. The prospectus is your friend when you want to know what the fees are.
Here's the bottom line: the more you pay in fund fees the lower your fund return will be. So look for funds that meet your standards and then find the ones that will cost you the least to own.