Getting Started with Mutual Funds

Investing with mutual funds sounds easy – and it can be if you approach it right.  As with anything and everything else in life you have to make some basic decisions before you start in order to get yourself off on the right footing.

Getting started with Mutual Funds- The key benefits to investing in mutual funds are:

Mutual Funds

1. Management – mutual funds have a manager.  This manager generally studies the particular industry that relates to the mutual fund, and watches all the potential stocks that the fund owns or could buy.  The manager trades stocks within the mutual fund to try and produce the highest return while maintaining the greatest stability.  In effect, a mutual fund manager is a portfolio manager for a portion of your account.

2. Diversification – because a mutual fund holds many stock positions, the risk factor for losing your money is lower.  If one stock held by the mutual fund goes down while the others continue to be stable or gain in value, the losses sustained by the one stock are offset by the others.  This can be key to safe investing. Of course, if all of the industry covered by the mutual fund is suffering, then the value of the mutual fund itself will also decline.

3. Ease of Investing – because mutual funds trade based on each day’s closing prices (with the exception of a few mutual fund families), and because they are less susceptible to major daily price swings, you don’t need to be an intraday trader or even a day trader to invest in mutual funds.  You can easily manage a retirement account or regular investment account by just examining your portfolio of mutual funds once a week or even once a month.

Successful use of mutual funds still requires some common sense and a measure of your time.  Just because you buy some highly rated mutual funds doesn’t mean you can then stick your head in the sand and pull it out 20 years later to find you are a millionaire.  A primary example of this is the high number of retirement accounts that lost 40-60% of their value during the 2007-2008 recession.

If you glance at any investment or money magazine, or do a search on the internet, you’ll be able to find a list of mutual fund companies, and all of them will assure you that they can produce the best results and you will be wise to go with “their” mutual funds.  But they are not all created equal; just look in the backs of magazines like Money Magazine and you can see which mutual funds and which mutual fund families have shown the best performances.

Investing in mutual funds requires these key actions:

1. Pick from one to three mutual fund families that appeal to you.

2. Create three to four groups of mutual funds so you can pick the best particular one or two funds from each group – this is where you’ll place your money.

3. Decide how frequently you are willing to trade or to change your investment portfolio.

These actions will require some time and some research on your part, but if that’s not possible, you can always go with recommendations. Good mutual fund recommendations can be found in magazines like Kiplinger’s or Money Magazine.  Recommendations can also be found in some personal investment software packages that have tested various mutual funds and groups of mutual funds.

Note: this doesn’t mean you can’t watch other groups of mutual funds from a wide variety of mutual fund families because this is a very valid way of creating another group or universe of mutual funds from which to choose.  There are other factors involved in picking mutual funds once you have decided on your primary mutual fund families.

Even with mutual funds, it is best to diversity and hold a number of mutual funds – four to eight would help provide you with a good mix of mutual funds.  There are mutual funds that cover just about any and every type of investment category – whether it’s a specific industry like energy, or a type of company (e.g., large vs. small).  There are also mutual funds comprised of stocks known for issuing dividends and mutual funds comprised of different types of bonds that issue regular payments.

An example of a portfolio based on mutual funds might contain the following:

  • Foreign Fund (e.g. Latin America)
  • Consumables Fund
  • Large Cap Fund
  • Hi-Yield Dividend Fund
  • Small Cap Fund
  • Energy Fund
  • Mid-Term Government Bond Fund

Other factors that can influence your choices when it comes to investing in mutual funds are:

The Class of the Mutual Fund – Typically mutual fund companies create a fund, but then create “classes” for the fund.  The most popular class is “no load”, meaning there is no trading fee for either buying or selling the mutual fund.   Other classes charge commissions when you buy or charge commissions when you buy and sell (these commissions can be steep and are taken right off the top of your investment dollars).  There is a symbol for each class of mutual funds, so be careful about the symbol you pick.

Mutual Fund Holding Requirements – Most companies require that you hold a mutual fund a minimum number of days before you sell it.  The hold times can vary by family and by individual mutual funds; typically, most holds are for 30, 60 or 90 days.  While you may be permitted to sell before the hold period is up, the mutual fund family will charge you a short-term trading fee (or penalty) to do so.  Keep in mind, there are times when the market goes into a free-fall, like we experienced at the beginning of the recent recession, when it may actually be worth it to pay the penalty to sell.

In and Out trading, aka: “round-trips” – A round trip is when you sell an mutual fund and then buy it back.  Mutual fund companies don’t like round-trips, and if you do them too often, usually four such trade pairs within 12 months, the mutual fund company will freeze your portfolio and may even cancel your account.  In other words, frequent trading in most mutual funds requires careful action.  The exceptions are Rydex Funds and ProFunds; but these mutual funds still have their unique characteristics and rules.

Raymond M.F. Dominick is the author of “Invest Safely and Profitably” (Your Success Guide), available from Amazon.

 

 

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