Short of winning the lottery or becoming the next American Idol, making wise investment decisions is how most of us will meet long-term financial goals and afford a comfortable retirement. But the demands of daily life can make starting and managing an investment portfolio seem overwhelming, and the complexities of the stock and bond markets often discourage many would-be investors. For those who aren’t ready for a career on Wall Street, mutual funds offer a convenient entrance to the world of stocks and bonds.
Why invest?
Investing in a mutual fund allows you to pool your investment dollars with other investors to share in the ownership of a widespread portfolio of stocks, bonds or other securities managed by financial professionals. For a relatively small initial contribution, you’re able to participate in the potential long-term rewards of investing, without the expertise and time commitment required to track the performance of many separate investments.
In addition to professional money management, mutual funds offer a number of attractive features, including:
Accessibility: Most investments in mutual funds are “liquid,” meaning it’s easy to sell your shares in the fund and have access to the money quickly if the need arises.Diversification: Most funds seek to reduce the risk associated with any single investment by investing in a range of industries, from computer chips to farming equipment, and investment types, such as stocks and bonds.Convenience: Many funds allow you to invest specified dollar amounts automatically every month, making investing easy while helping your money grow steadily over time.Flexibility: There are mutual funds designed to meet every investment goal, and it’s easy to transfer money from one fund to another as your needs for stability and income change.In contrast to these benefits, mutual funds can have some drawbacks when compared with “do-it-yourself” investing. Since most mutual funds are designed to limit risk, it may be possible to earn higher returns if you have the time, knowledge and desire to research and monitor individual stocks and bonds.
The right fund
If you decide to invest in one of thousands of available mutual funds after weighing the benefits and drawbacks, how do you choose the right one? The first step is to determine your investment goals and find the type of fund that matches your plan. Answering two important questions can help you narrow the field:
Are you investing for growth or income? The objective for some investors is to grow their original investment for long-term goals like retirement or a child’s college education. Stock funds, also known as equity funds, offer the greatest opportunity to realize that goal, but also present a medium to high level of risk.
If your top priority is to secure a steady source of income to use now, a good choice may be bond funds. Bond funds also are subject to certain risk factors, but the risks often can be controlled with greater certainty than stocks.
Investors seeking a combination of growth and income can find mutual funds designed to provide a balance of both elements. To learn more about the differences between stocks and bonds and their associated risks, you can visit any number of investing Web sites that offer basic information for free.
How much time do you have to invest? As a general rule of thumb, the longer you’re able to keep your money in a mutual fund, the more risk you can tolerate. For example, someone in her 20s who is investing for retirement may choose an aggressive growth fund, which invests in riskier stocks but offers the potential for higher returns over the long term. At the other extreme, a retired person whose goal is to preserve his original investment may opt for a money market fund or short-term bond fund, which usually produces a smaller return with lower risk. In addition to these examples, fund types exist at every level of the risk/reward spectrum.
Going solo or together
Once you know what type of fund is right for you, consider whether you prefer to invest in individual mutual funds, which can be purchased through a financial services firm, or in a managed investment plan like the military’s Thrift Savings Plan (TSP) or an Individual Retirement Account (IRA).
Managed investment plans usually offer a range of mutual funds that can be mixed and matched to create the right investment strategy for your goals. Most importantly, these plans are designed to help investors meet specific goals, such as saving for retirement or a college education, by offering certain tax advantages to help the account grow more quickly. However, managed investment plans do have restrictions on contributions and withdrawals.
While managed investment plans can offer terrific benefits such as tax-deferment and matching funds from an employer, they also are less liquid and usually present a limited number of funds in which to invest. Many investors choose a combination investment strategy to obtain the best of both worlds — taking full advantage of a managed plan, while also investing directly in mutual funds that don’t have contribution limits and are available for withdrawal at any time.
Down to details
Regardless of whether you’re investing in several mutual funds through a managed plan, or in a single fund through your investment firm, it’s essential to review the key elements of the funds you’re considering. Not all funds in the same category are alike, so conducting some further research can help you make the right fund choice and the most of your money.
Read the fund’s prospectus, which outlines its investment objectives, strategies, past performance and minimum required investment.Compare the costs of each fund. Funds charge fees for annual operating expenses, and some also charge sales commissions, known as “loads,” which can add up over time to erode your investment return.Use the Internet to visit well-known investment sites such as Morningstar.com, which provide details about each fund.Ask a financial advisor to analyze your situation and consider his input before you make a final decision.Though the volume of information available about mutual funds may seem daunting for newcomers, sticking to basics will help guide you toward investing success.
Mitch Swanda is a salaried Certified Financial Planner™ practitioner with USAA Financial Planning Services, one of the USAA family of companies. USAA is a diversified insurance and financial services organization that has served the military community since 1922. Swanda also served six years on active duty in the U.S. Navy.
