A financial adviser is only as good as his or her ability to explain different concepts to their clients. Many people don’t know how to actually go about making financial decisions, so they instead pay to have someone do it for them.
In the case of mutual funds, I think it’s something that all investors would benefit from knowing about, because there is a good chance they will encounter them at some point in life.
This is especially common in professional settings, as many company plans require the use of mutual funds over stocks to manage risk. Think about what would happen if investors put all of their savings into the stock of one company and what would happen if that company went under. All of that retirement money would be gone.
That’s why it pays to know about mutual funds, and that’s why I’m going to tell you all about them.
What Are They?
A mutual fund is essentially money that is pooled together and managed by a professional. The purpose of these pools is to give investors easy access to securities that are in a diverse portfolio. When you buy shares in a fund, what you’re really buying is a series of small positions in the securities that make up that fund. These could be stocks, bonds, or many other different types of investments.
The total holdings of these funds can range from millions to billions and they can have a few investors or a few thousand. On top of all of that, a small percentage, think 1 or 2, of the money being managed is used to pay for the fund’s upkeep and management fees.
In buying a fund’s shares, you hope that the fund manager does a good enough job at choosing so that the picks do well. While performance varies, just because you buy into a fund that is having a good year does not guarantee you will profit. Despite popular belief, looking at 5 and 10-year periods doesn’t always guarantee you will make money.
Instead, you want to take your own tolerance for risk into account when choosing a fund or manager. How well will you handle your investments going up and down without giving in to the desire to pull your money out? The market is too unpredictable for some, and they may prefer to put money into bonds or money market funds instead. These are generally conservative investments that seek to provide stable incomes.
Once you know what mix of funds you want to choose, you can start looking at what fund families you like. This part can be tough for some, because you may find multiple fund families that have similar funds. Does it matter which you pick, ultimately?
Some will do better than others, but having to choose between companies is almost never easy.
It helps to look at the fund’s culture or sense of style. Some companies are aggressive investors, while others prefer to use indexes as their benchmark. By learning the investing policies of the fund family, you can find the direction you want to go in.
What Are the Types of Funds?
Once you know what your tolerance for risk is, you have to make sense of the financial terms that will come with the funds you want to buy. It would be easy if funds had names that clearly spell out who they’re for, but that isn’t the way this works. Instead, there are standard terms such as the following:
- Large-Cap Growth Funds – These funds invest in companies that want to grow, and the companies involved typically reinvest their money instead of paying out dividends. The tech sector has many growth stocks. These companies have a great opportunity for profit, but are not for the risk averse.The term “Large-Cap” typically means these companies have market value of at least $5 billion, but there are also mid cap, small cap, and even micro cap, for companies of varying sizes.
- Large-Cap Value Funds – With these funds, managers look for companies that they believe should be trading at higher prices. This might mean companies that have strong profits, but have some underlying issue. A good manager will find these inefficiencies.
- Blend Funds – These mix growth and value stocks. They use benchmarks like the S&P 500 or Dow Jones Industrial Average to determine success. If they outperform, then the manager has done his job.If they trail behind, then investors are losing because they could have bought index funds which are typically lower in cost. These are good funds for anyone who wants to pursue growth without a super aggressive investing strategy.
- International Funds – With these funds, managers look beyond the US and at the companies in other countries that are making money. These include “emerging market” funds, which are risky because they involve funds in young economies.There are also global funds, which have international companies as well as those in the US. Investing in these types of funds can help to increase the diversification of your portfolio, but you have to remember that you are playing with risks related to potentially unstable currencies and governments.
- Sector Funds – With these funds, all of your investments are in one area. They tend to be more unstable because of the limited scope, but the risk level changes with the sector. Utilities, for example, might be less volatile than technology stocks. Some investors pile into certain sectors when they think there might be a boom, like we saw with oil around 2001.Others choose to use sector funds as a hedge against other mutual funds that they have. Some of the most popular sector funds are in financial services, utilities, and precious metals.
Why Don’t People Like Mutual Funds?
Even with the features of mutual funds, there are people who don’t particularly like them. The main reasons for this are that mutual funds tend to be expensive compared to index funds, and the people who manage them have not always shown the best returns.
What connects these two? As an investor, you pay for the fund’s expenses, so you want to see a return. So what happens when it doesn’t perform well and, on top of that, you have to pay the fees and charges? You’re not going to be happy about that, I bet. This is why people consider low-cost index funds.
So you know what mutual funds are and what the related terminology means, but what funds should you choose? Like I said, you want to take your level of risk tolerance into account.
You also want to think about why you want to invest and for how long. If, for example, this is a fund you will hold onto until retirement, then consider something with some exposure to stocks. Because you have time, you can withstand any coming volatility.
I would suggest the opposite for someone who wants to save so they can buy a house in six months. If you want something with some diversity, consider looking for something with a mix that exposes you to the market and doesn’t have high fees. As I mentioned, it’s the fees that really eat away at your earning potential.
If you have any questions about mutual funds, feel free to send me a message. I’ll be more than happy to help!