Before 1924, mutual funds weren’t a thing — they didn’t even exist! But when three money managers from Boston decided to combine their money, a new industry was born. Today, it controls trillions of dollars worth of assets, and it gives small investors a chance to use systematic investing methods to increase their wealth.
But how does one choose a good mutual fund? We have prepared ten tips that every investor should learn by heart before picking a mutual fund and investing in it.
1. Buy no-load mutual funds
Now, mutual funds that pay 5% of the assets, known as the sales load, to the seller are not a bad option if we’re wealth managers. However, when building a portfolio, we ought to stick to no-load mutual funds. The reason for this is simple — when there’s no load, we can easily use all the money in the fund and put it to better use, i.e., use it to make ourselves more money. Meanwhile, by paying sales loads, we’ll end up with less money after a few years because we’ve lost a part of our capital.
2. Don’t disregard the expense ratio
Every mutual fund has an expense ratio, which is the amount of money needed to run the fund properly. Things like analyst salaries, electricity bills and office leases — those have to be paid somehow. Thus, when picking mutual funds, we need to pay attention to this ratio, as it could easily spell disaster in regard to our money-earning success. A mutual fund with a ratio of 0.50% is a better choice than one with a 1.5% ratio — it’s a smaller obstacle to overcome!
3. Stay away from high turnover ratios
Although the turnover rate, or the percentage of the mutual fund portfolio that gets bought and sold every year, is important, we have to avoid dreaming big here. Why? Well, it’s simple. The bigger the turnover, the higher the taxes. So if we’re not investing via a non-profit, Roth IRA, a 401k or Traditional IRA, we’ll lose a big chunk of our funds when the taxes are due.
4. Get the right, knowledgeable and disciplined management team
Just like in any other business, having a team that knows nothing about how mutual funds work or a team that has a bad track record could destroy our dreams. Thus, we should make sure our mutual fund management team consists of talented and disciplined individuals who know how to overcome obstacles without compromising the security of the fund. Moreover, we ought to ensure the managers have invested a part of their net worth as well. That way, we’ll all have to share the risk.
5. Determine what your philosophy is
Before choosing a mutual fund, we’ll need to figure out what kinds of investors we are. Are we interested in value or are we looking for growth? How about blue-chip companies — are healthy dividend yields our main point of interest? Knowing our investing philosophy is crucial, as it can essentially determine how successful we are at investing in mutual funds.
6. Diversify, diversify, diversify!
As they say, don’t put all of your eggs in one basket.
Indeed, in investing, if we don’t know how to recognize a company’s intrinsic value, diversification makes sense. But how to go about it? Well, here are a few guidelines:
- Spread out your assets; don’t keep them in the same fund family.
- Stocks are great, but try to find other investment opportunities, like international funds and real estate funds. These can also offer fantastic returns, and they certainly make investing a lot more fun.
- Try to avoid those that make heavy sector or industry bets.
7. When in doubt, opt for index funds
If we have about ten years or more to invest and we’re looking to save up some money to compound it over a longer period of time, then we can always opt for index funds. These have very small expense ratios, low turnover rates, and on top of that, they are quite diverse. The leaders in this category are definitely Vanguard and Fidelity, but other major ones also include the Dow Jones Industrial Average and the Wilshire 5000.
8. Be careful about international funds
Although quite tempting, investing in international funds can be a total disaster if we opt for emerging markets that could “blow up in flames” due to political and economic struggles. Thus, if we decide to invest overseas, then we should opt for Great Britain, Brazil, Germany or Japan, for example.
Investing in international funds is a good idea, and it could help us build our wealth over time. Moreover, if the American equities come crashing down, it doesn’t mean the foreign ones will go down as well. Still, know that investing overseas entails greater expenses.
9. Pay attention to the mutual fund’s benchmark
We need to know what our goals are when we opt for a certain mutual fund. Moreover, we need to know what we should compare it to so that we can determine if it’s successful or not. That way, we’ll also find out if the portfolio manager is keeping our investing in check.
Knowing how to find these benchmarks (we can google them) is crucial, as we’ll find out more about the mutual fund in question. We can even use them to view historical data and evaluate them. In fact, we can get an analyst to look at them and tell us what they think of the management team and if they’re doing a good job or not.
10. Dollar cost average all the way
Investing for longer periods of time can be risky, especially if we’re not paying attention to all the factors. However, one thing will surely help us out — dollar cost averaging. With this, we can lower the risk and even reduce the overall cost basis of our investments. Thus, investing in mutual funds will be a total success and probably the smartest decision we’ve ever made.