Mutual funds are one of the most popular investments in existence, but are they good investments? It depends on the particular mutual fund you are talking about, and if it fits with your goals and objectives.
What is a Mutual Fund?
First you need to understand what a mutual fund is. There are over 7,000 mutual funds, each with a different goal and objective. Some invest in bonds, some in stocks. Some are conservative, some are aggressive. Some are structured to produce dividends and interest income, others invest for growth. To pick a mutual fund that will be a good investment for you, you have to know what your goals and objectives are. If you're not sure what your goals are check out Investing Basics - Safety, Income or Growth.
One of the advantages of a mutual fund is it allows you to capture the returns of an entire market, or collection of investments, without having to buy and sell individual stocks and bonds. For example if you bought an S&P 500 index fund you would experience the historical stock market returns of the S&P 500, without having to buy all 500 stocks.
Best Mutual Funds
Morningstar is a company that provides statistics and research on mutual funds. Once you have narrowed down the type of fund that matches your goals, their research shows there is a proven way to find funds that are most likely to have the best performance. Its by finding funds in each category that have the lowest fees.
Mutual Fund Fees
The lower the investment expenses you pay, the higher your returns. Learn which mutual fund fees to pay attention to and look for funds that have low fees. Your time is better spent doing this type of research than trying to find funds that had the highest returns last year. Last year’s results are no indication of what might happen this year. You want a fund that consistently invests according to its goals and objectives and has low fees.
Active Vs Passively Managed Funds
It pays to learn the difference between active and passive investing. In a nutshell, actively managed mutual funds trade in and out of securities, while passive funds buy and hold a specific collection of securities. Although from year to year some actively managed funds outperform their passive counterparts, academic studies show that over the long term passively managed funds as a group outperform their actively managed peers.
How to Use Mutual Funds
A mutual fund can be not only a good investment, but a great investment when you use it properly.
First, pick a mutual fund family to work with. I’d recommend you start with my best index fund list.
Next, figure out your goal. If you are investing retirement money that you won’t need to touch for twenty years, you can pick a more aggressive fund like an equity fund, and leave it alone. If you are retiring in a few years, having all your money in an equity fund may not be such a good idea. You may want to look at a balanced fund. It can be helpful to use an investment risk scale to classify funds and match them to your goals.
I’d also recommend you take some time creating an investment plan before you start picking funds.
Mutual funds can be quite an effective investment when used to build a portfolio that follows an asset allocation model. In simplified terms, your asset allocation model tells you how much of your money should be in stocks verses bonds, and then within stocks how much should be in U.S. stocks verses international stocks.
Once you have an allocation model you would pick a mutual fund to fill in each asset class; for example an S&P 500 index fund for U.S. stocks, an international equity index fund to fill in the international piece of your portfolio, and a total market bond index fund for the bond portion.
Mutual Funds for Retirement
Some mutual funds are designed just for producing income. Several mutual fund families have created a series of retirement income funds that pay out regular monthly or quarterly income. I think these are good options for someone in retirement who wants to manage their own money.
Other mutual funds called dividend income funds focus on maximizing income by selecting dividend paying stocks.
Bottom line: mutual funds are a good investment if you pick funds with low fees that match your goals and objectives.