This week… How to select a mutual fund and the pros and cons of investing in a mutual fund…
How do I select a fund that’s right for me? Every fund has a particular investing strategy, style or purpose; some, for instance, invest only in established companies. Others invest in start-up businesses or specific sectors. Finding a mutual fund that fits your investment criteria and style is absolutely vital; if you don’t know anything about biotechnology, you have no business investing in a biotech fund. You must know and understand your investment.
Pros and Cons
Mutual funds have less risk than buying individual securities because they are a diversified investment. That means you aren’t as dependent on an individual stock, or bond, and its underlying company. If one of the companies goes bankrupt, you own many more stocks to protect your investment.
Actively-managed funds give you the benefits of professional stock picking and portfolio management. You don’t have to research thousands of companies. The managers are experts in each field. It would be almost impossible for you to become an expert in all the areas in which you’d like to invest.
But it still takes a great deal of time to research mutual funds. To make it worse, the managers of funds change. When that happens, it could affect the performance of your fund even if the sector is doing well. That’s important because managers continuously change the stocks they own. Even if you look at the prospectus, it might not reflect current stock ownership. You don’t know what you are buying specifically, so you are relying on the expertise of the manager.
The prospectus will warn that past performance is no guarantee of future returns. But past performance is all you have to go on. There’s a good chance that a fund that’s outperformed the market in the past underperform in the future. That’s especially true if the manager changes.
The most significant disadvantage is that mutual funds charge annual management fees. That guarantees they will cost more than the underlying stocks. These fees are often hidden in several places in the prospectus.
To pick good mutual funds, you’ve got to understand your investing goals. Are you saving for retirement or setting aside some extra cash for a rainy day? Stock funds would be best for long-term retirement investing, while a money market fund is best for short-term savings.