Mutual funds can be a smart place to start investing. They’re easy to access and don’t require you to read any balance sheets or even know what a balance sheet is. They’re also less likely to leave you high and dry than an individual company, which is more likely to go out of business.
“A mutual fund is an investment vehicle that pools many individual investors’ money together and is managed by professional investment managers,” says Dennis Baish, senior investment analyst and portfolio manager at Fort Pitt Capital Group in Pittsburgh, Pennsylvania.
They allow you to turn the selection of individual stocks, bonds and other investments over to professionals. This makes mutual funds “ideal for those who do not have the time or ability to select individual securities, but still want to participate in the market,” Baish says.
If you have a 401(k) or another employer-sponsored plan, you’re probably already investing in a mutual fund or two. Typically these plans default you into a target-date retirement fund (more on those later), but there are many, many mutual funds to choose from.
How to Start Investing in Mutual Funds
Pick an area of the stock market and there’s bound to be a mutual fund to help you invest in it. Whether you want to own only the biggest U.S. stocks or the smallest; if you want to invest in China or South America; if you want the security of bonds or the income from real estate without needing to own either directly, there are mutual funds to provide that exposure.
“Typically, a mutual fund will specialize in certain segments of the market whether just stocks, just bonds, just real estate,” Baish says. He recommends that beginning investors select a few different funds to start.
“By selecting a number of different mutual funds, individual investors can usually get diverse exposure to the overall investment landscape,” he says. “Since not all areas of the market or investment managers perform well at the same time, broad diversification among different mutual funds can be an important component of mutual fund investing.”
16 Investing Questions That Intimidate You, But Shouldn't. ]
Choosing Mutual Funds for Your Portfolio
When it comes to choosing which mutual funds to invest in, start with your investment goal and time frame. These two elements will help determine what type of mutual fund you should use.
For instance, if you’re investing for retirement 30 years in the future, you can choose a more aggressive (read: stock-heavy) mutual fund than someone investing to buy a yacht in five years. The shorter your time horizon, the more conservative your mutual fund should be, generally speaking. Longer-term investors can afford to take on more risk as they’ll have time to wait out any stock market declines.
“In many cases, an allocation fund is a good place to start,” says Will Lofland, director, head of intermediary distribution at GuideStone Capital Management in Dallas. “This is a fund with a specific risk target that will provide the investor [with] broad diversification.”
An investor with a 30-year retirement goal who isn’t afraid of seeing her investments fluctuate in value between now and then could use a 90/10 or 80/20 asset allocation fund. These will invest 90% or 80% of their assets in stocks, respectively.
Less aggressive investors may opt for a 70/30 or 60/40 allocation.
“Another option would be a target-date fund,” Lofland says. “These funds are something that you select that have a year in the future that corresponds to some type of goal.”
The retirement saver who plans to retire in 30 years could use a 2050 target-date fund. This would start at a more aggressive, stock-heavy allocation but gradually become more conservative as the target date nears.
It’s worth noting that while target-date funds are designed for retirement investing, you can use them for any investment goal. Simply choose the fund associated with your end-goal date.
“More savvy beginners can build allocations themselves, but need to carefully study each fund they are considering, and to make sure that they are building a properly diversified allocation,” Lofland says.
8 Free Investment Classes for Adults and Teens ]
How to Evaluate Mutual Funds
“Choosing which mutual funds to invest in can be intimidating for a new investor with little investment knowledge,” Baish says. “As you start your mutual fund investing journey, there are some things that are important to think about as you select mutual funds.”
He says to look for a mutual fund with a good long-term performance that compares well against other mutual funds investing in the same area of the market.
“Comparing a bond fund against a stock fund isn’t a fair comparison because both funds invest in different areas of the market,” he says. Instead, “look to compare a U.S. large-cap mutual fund with another U.S. large-cap mutual fund. This will give you a better idea of performance.”
And when evaluating performance, focus on the long term. “Short-term performance is less relevant than long-term performance,” Baish says.
The same holds for the investment professionals managing your fund. “Look for investment managers that have a long history of investing,” he says.
Simon Calton, CEO of the Carlton James Group, says his biggest tip for anyone investing in mutual funds is to look at how the fund manager did during the last economic downturn.
It’s been easy for mutual funds and their managers to do well in the extended bull market; what will differentiate the best managers is how they performed during stock market declines.
“You need to see that they have seen the ups and downs because it’s all well and good understanding how to make money when the going is good; it’s about how you buckle down and work through when things” aren’t going so well, he says.
You can find information on a given mutual fund’s past performance and manager experience on sites like U.S. News & World Report’s mutual fund pages or the fund company’s own website.
7 Things to Know About Money Market Mutual Funds. ]
“Fund company websites are a great tool that offer information such as fees, commentaries, investment outlook, performance reports and much more,” Baish says. “Becoming knowledgeable about mutual fund investing will help you select the mutual funds that you are most comfortable with.”
8 Great Benefits of Mutual Funds