A Beginner's Guide To Mutual Fund Investment

Investing in mutual funds is a great way to build a diversified portfolio without too much hassle. They are a collection of investors' money that fund managers use to invest in stocks, bonds, and other securities. They are suitable for both beginners and experienced investors as they offer diversification and can target specific areas of growth.

There are two main types of mutual funds: active and passive. Active funds are managed by professionals aiming to beat the market, while passive funds aim to replicate the performance of a market index. Passive funds tend to have lower fees and have consistently outperformed active funds over the long term.

When investing in mutual funds, it is important to consider your financial goals, the fund's investment strategy, past performance, fees, and the type of account you want to invest through. You can buy mutual funds through an employer-sponsored retirement plan, an online brokerage, or directly from the fund company.

Remember to always do your research and understand the risks and fees associated with mutual funds before investing.

Understand the different types of mutual funds

There are several types of mutual funds, each with its own unique characteristics and risk-return profiles. Here are the main types of mutual funds you should know about:

• Stock Funds or Equity Funds: These funds are made up of stocks from corporations, usually from the United States (domestic funds) but can also include international companies. They can be further categorised into large-cap, mid-cap, or small-cap funds based on the size of the companies. Equity funds are actively managed by professionals and carry a higher risk but also offer higher potential returns.
• Bond Funds: Bond funds invest in income-generating securities issued by governments and/or corporations. They typically pay regular dividends and are suitable for investors seeking a consistent income. Bond funds are generally less volatile than stock funds but can still experience capital losses during rising interest rates.
• Money Market Funds: These funds invest in short-term, high-quality debt instruments issued by governments, states, local municipalities, and corporations. They are considered low-risk investments but may offer lower returns compared to other types of funds. Examples of assets in money market funds include treasury bills, certificates of deposit, and commercial paper.
• Index Funds: These are passively managed funds that aim to replicate the performance of a specific market index, such as the S&P 500. Index funds have gained popularity due to their low costs and the rise of passive investing strategies. They tend to have lower fees than actively managed funds.
• Sector Funds: Sector funds focus their investments on a specific industry or sector, such as technology, healthcare, or real estate. They allow investors to concentrate their investments in an area they believe will perform well without having to select individual stocks. However, sector funds are generally not recommended as a core holding due to their lack of diversification.
• Balanced or Hybrid Funds: These funds offer a mix of stocks and bonds, typically with a fixed ratio, such as 60% stocks and 40% bonds. The aim is to balance the growth potential of stocks with the stability of bonds. Balanced funds are designed to provide both capital appreciation and income while managing risk.

In addition to the main types mentioned above, there are also some less common types of mutual funds, including asset allocation funds, hedge funds, commodity funds, and real estate investment funds. Each type of mutual fund has its own investment objectives, risk profiles, and potential returns. Investors should carefully research and understand the characteristics of each fund before making investment decisions.

Set clear investment goals

Setting clear investment goals is a crucial step in achieving financial success. Here are some essential tips to help you set clear and effective investment goals for mutual funds:

Identify Your Goals

Before investing in any mutual fund, it is imperative to clearly understand your financial goals and objectives. Ask yourself, "What do I want to achieve with this investment?" Your goals can vary from long-term capital gains for retirement planning to shorter-term goals such as saving for a child's education or a dream vacation. Each goal will have different time horizons, risk tolerances, and investment strategies.

Assess Your Risk Tolerance

Different mutual funds carry different levels of risk. Some funds, such as growth funds, focus on capital appreciation and hold a high percentage of their assets in common stocks, making them riskier. In contrast, income funds that invest in bonds and debt instruments are generally more conservative and stable. Evaluate your risk tolerance and choose funds that align with your comfort level.

Determine Your Time Horizon

Consider how long you plan to hold your mutual fund investments. Are you investing for the long term, or do you have shorter-term goals in mind? Mutual funds typically have sales charges, so it's essential to plan for an investment horizon of at least five years to mitigate the impact of these charges on your returns.

Choose the Right Type of Mutual Fund

Mutual funds can be categorized into different types, such as growth funds, income funds, balanced funds, and target-date funds. Based on your goals and risk tolerance, select the type of fund that aligns with your objectives. For example, if you have a long-term goal with a higher risk tolerance, consider growth funds. On the other hand, if current income is more important to you, income funds might be a better choice.

Set Clear Monetary Targets

As part of setting clear investment goals, define the monetary value required to achieve each goal. This will help you determine the amount you need to invest and the potential returns needed to reach your target. For instance, if you're saving for a child's education, estimate the future cost of tuition and living expenses to set a clear monetary goal.

Prioritize Your Goals

Not all financial goals carry the same weight. Prioritize your goals based on their importance to you and your timeline. For example, saving for retirement might be a higher priority than saving for a vacation. By prioritizing, you can allocate your resources effectively and ensure that you're on track to achieve what matters most to you.

In conclusion, setting clear investment goals is a fundamental step in your investment journey. It provides direction, helps you make informed decisions, and increases your chances of achieving your financial aspirations. Remember to review and adjust your goals periodically as your life circumstances change.

Research and compare funds

When it comes to investing in mutual funds, there are a plethora of options to choose from, which can make the fund selection process quite challenging. Conducting thorough research and comparing different funds is crucial to making an informed investment decision. Here are some detailed guidelines on how to research and compare mutual funds effectively:

Understanding Your Investment Objectives and Risk Tolerance

Before embarking on mutual fund research, it's essential to introspect and define your investment goals. Are you saving for retirement, a child's education, or a down payment on a house? Each goal has distinct timelines and expected returns. Assessing your risk tolerance is equally important. Higher potential returns often come hand in hand with increased risk. Understanding how much risk you are comfortable with will help narrow down suitable fund categories.

Comparing Mutual Funds: Parameters to Consider

Performance

Evaluating the performance of a mutual fund involves analysing its historical returns over different market cycles, not just during bull markets. Compare the fund's returns to benchmarks and similar funds. Consider both short-term and long-term returns, such as 1-year, 3-year, 5-year, 7-year, and even 10-year returns. However, remember that short-term returns can be volatile and may not always be indicative of the fund's true performance.

Consistency of Returns

It's not just about the returns themselves, but also about how consistently the fund has been able to deliver those returns. A mutual fund that consistently generates the same level of returns over the medium and long-term is often a better choice, as it increases the probability of achieving your investment goals and provides peace of mind.

Downside Protection

During volatile market periods, it's important to assess how well a mutual fund protects your investment from losses. A fund that offers good downside protection ensures that your investment losses are minimised in the event of a market correction.

Risk Profile

The risk profile of a mutual fund deals with how volatile it is and the types of assets it invests in. Some funds invest in risky assets like small-cap stocks, while others focus on safer options like bonds. The level of risk you're comfortable with will guide your choice of fund.

Investment Strategy

Understanding the investment strategy of a mutual fund involves looking at the types of assets it holds and its overall approach. Does it follow a growth, value, or income-focused strategy? How active is the fund manager in making investment decisions? The investment strategy should align with your financial goals and risk tolerance.

Expense Ratio

The expense ratio is an annual percentage that covers the fund's operating costs, deducted from your returns. It's important to consider this ratio, as it can impact your overall returns. Lower expense ratios are generally preferable, as they maximise your net returns.

Portfolio Details

Analysing the portfolio details of a mutual fund provides insights into the specific sectors and stocks the fund has invested in. This information helps you assess the fund's concentration risk. If a fund has a large portion of its portfolio invested in a specific stock, bond, or sector, it may carry a higher degree of concentration risk.

Tools for Researching and Comparing Mutual Funds

To make the research and comparison process more efficient, you can utilise various tools specifically designed for this purpose. For instance, FundVisualizer offers a free mutual fund comparison tool that enables advisors to compare funds across different asset classes and investment categories. It allows you to build interactive charts and PDFs for clients, saving all your research for future reference.

Common Mistakes to Avoid

When researching and comparing mutual funds, there are some common pitfalls to be aware of. Firstly, avoid comparing only short-term returns, as this data can be misleading, especially for equity funds that are prone to high levels of short-term volatility. Secondly, refrain from basing your investment decision on a single criterion, such as returns or risk. Consider multiple factors, including consistency of performance, risk, portfolio details, and fund management, to make a well-informed choice.

Choose a brokerage account

You can open a brokerage account quickly online. Many brokerage firms allow you to open an account with no upfront deposit, but you will need to fund the account before you buy investments. You can transfer money from your checking or savings account or another brokerage account.

You own the money and investments in your brokerage account and can sell investments at any time. The broker holds your account and acts as a middleman between you and the investments you want to buy. You can open more than one brokerage account, and there's no limit on the amount of money you can put into a taxable brokerage account each year. There should be no fee to open a brokerage account.

There are two main types of brokerage accounts:

• Online brokerage account: If you want to purchase and manage your investments, an online brokerage account is for you. An account with an online brokerage company enables you to buy and sell investments through the broker's website. Discount brokers offer a range of investments, including stocks, mutual funds, and bonds.
• Managed brokerage account: A managed brokerage account comes with investment management from a human investment advisor or a robo-advisor. A robo-advisor provides a low-cost alternative to hiring a human investment manager. These companies use computer programs to choose and manage your investments based on your goals and timeline. Robo-advisors may be a good fit if you want a hands-off approach to your investments.

When choosing a brokerage account, you should consider the following factors:

• Affordability: Mutual fund investors can face two types of fees: transaction fees from their brokerage account and expense ratios and front- and back-end "sales loads" from the funds themselves. Look for a broker with a long list of no-transaction-fee mutual funds to avoid transaction costs. Also, consider the expense ratios of the funds offered by the broker, as these can eat into your returns over time.
• Fund choices: Workplace retirement plans may only offer a limited number of mutual funds. Consider choosing a broker that offers a wide range of funds, including index funds and ETFs, to give you more variety in your investment options.
• Research and educational tools: With more fund choices comes the need for more research and due diligence. Choose a broker that provides comprehensive research and screening tools to help you make informed investment decisions.
• Ease of use: The broker's website or app should be user-friendly and easy to navigate.
• Interactive Brokers IBKR Lite: Offers more than 48,000 funds, over 19,000 of which have no transaction fees.
• Charles Schwab: Offers high-quality customer service, four free trading platforms, a wide selection of no-transaction-fee mutual funds, and $0 commissions for stocks, ETFs, and options.
• Vanguard: Pioneer in low-cost index funds, offering thousands of proprietary funds for different goals and values, although many of these funds have high minimums.
• Fidelity Investments: Offers four zero-fee funds and nearly 3,400 no-transaction-fee mutual funds.
• E-Trade: Provides access to more than 6,000 no-load, no-transaction-fee mutual funds, along with research and screening tools to help you make investment decisions.
• Ally Invest: Offers access to more than 17,000 mutual funds and recently cut its commission on no-load mutual funds to $0.
• J.P. Morgan Self-Directed: Offers about 3,000 no-transaction-fee mutual funds, a customizable screener for mutual funds and ETFs, and convenient access to all Chase accounts through a single dashboard.

Manage your portfolio

Managing your mutual fund portfolio is not difficult if you plan it well in advance. Here are some tips to help you manage your portfolio:

• Focus on diversification: Diversification helps prevent the risk of losing all your investments at once. In a mutual fund portfolio, diversification means having multiple baskets of investments, each serving a different financial objective. Allocate your funds across various asset classes such as stocks, bonds, and cash to mitigate the risk associated with any one asset class encountering a decline.
• Rebalance your portfolio: Rebalancing is vital to maintaining a robust mutual fund portfolio. It involves regularly buying and selling mutual fund units to realign your portfolio's weightings with your target allocation. This ensures a proper mix of equity, debt, and investments tailored to specific themes.
• Consider your investment tenure: The timeframe of your investment is crucial in shaping your asset allocation strategy for mutual funds. Younger investors or those with long-term goals have more flexibility to navigate market fluctuations and can allocate a larger portion of their investment to equity mutual funds, which offer higher potential returns despite higher risk. As your goals draw nearer, consider shifting to a more conservative strategy with an increased allocation to bonds, which provide lower risk and a more dependable income stream.
• Balance risk and reward: It is important to strike a balance between risk and reward that aligns with your investment horizon and risk tolerance. An aggressive investor has a higher tolerance for risk and emphasizes growth potential, while a conservative investor prioritizes capital preservation and has a lower tolerance for risk.
• Monitor and adjust your portfolio regularly: Regularly review your mutual fund's performance to identify any deviations from your target asset allocation and make adjustments as needed. It is generally recommended to review and consider rebalancing your portfolio annually or whenever there are significant changes in your finances or investment goals.

Frequently asked questions