About 96 million people own mutual funds, according to the Investment Company Institute, a trade organization for the mutual fund industry. So the chances are pretty good that you may already own some funds - but with more than 10,000 of them on the market, how can you know you’re picking the right ones?
Of course, just by owning mutual funds, you get at least two key advantages. First, you’ll get professional management, which means that a highly trained investment expert will be choosing the securities that go into your mutual funds. And second, mutual funds offer a degree of diversification because each fund owns a variety of stocks, bonds, government securities and other investments. Keep in mind, though, that diversification can’t guarantee a profit or protect against a loss.
However, even though all mutual funds offer you these two benefits, you can’t just buy a bunch of funds, willy-nilly, and assume you’re making the right moves. Many people think that if one growth-oriented mutual fund gives them a chance to have their money grow, then several growth funds will enable them to make really big profits. But many growth stocks look alike. So, if you bought several of these funds, you might wind up with a lot of similar stocks in slightly different packages. And if one of your funds is adversely affected by market circumstances, the others could be similarly hit, so you might end up losing the benefit of diversification.
How can you avoid buying a bunch of nearly identical growth funds? Ask your financial advisor for the prospectuses or annual reports of all the funds you’re considering. These documents typically list their funds’ individual holdings and the percentages of different types of assets. If you see too much overlap between a fund you’re considering and one you already own, consider looking elsewhere for better opportunities.
A mutual fund’s prospectus also includes the fund’s investment objectives, risks, charges, expenses and other important information, so be sure to read the prospectus carefully before investing or sending money.
Types of Funds Thus far, we’ve mostly discussed growth funds. To create a diversified mutual fund portfolio, though, you’ll need to consider other types of funds, such as the following:
• Growth-and-income funds: As the name suggests, growth-and-income funds strive to achieve a mix of capital growth and current income. These types of funds invest in dividend-paying stocks and some bonds.
• Bond funds: You can find mutual funds that focus on corporate, Treasury or municipal bonds. While all these funds seek to provide income, they differ in risk level and tax consequences.
• International funds: International funds invest in stocks in non-U.S. companies. Although such funds have the potential to achieve large gains, they are frequently volatile, as they are subject to currency fluctuation and political and economic risks.
• Sector funds: “Sector” funds primarily invest in the stocks of a particular industry or segment of the economy, such as technology, health care or financial services. Sector funds are, by design, less diversified than other types of mutual funds; consequently, they are generally more risky.
Your financial advisor can help you find the right mix of mutual funds for your individual risk tolerance, long-term goals and time horizon. So, pick your funds carefully. Today’s decisions can have a big impact on your financial future.
Cardella is a financial consultant with Edward Jones in Hinesville.