Wednesday, May 25, 2011

How to Choose a Mutual Fund

Mutual fund is a portfolio of stocks, bonds, real estate, and other securities put together from hundreds and thousands of small investors, whereby the fund’s manager buys stocks, bonds or other securities with it. Mutual funds are a good choice for your investments, since you can choose how much you want to invest. Furthermore, the fund managers are professionals who can take care of your investments better than you could do yourself, considering they have more knowledge and resources.

You can choose between many categories of mutual funds. For example: growth funds which buy shares of burgeoning companies; government bond funds; sector funds which buy shares of companies in a particular sector, such as technology or health care; and index funds, which buy shares of every stock in a particular index, such as the S&P 500. If you want to keep down your tax bill, you can also try municipal bond funds.

So, how to choose a mutual fund when they all claim to offer low risks and good returns on your investment?

First, set your investment goals. If you are a long-term investor, mutual fund is the right thing for you. Bear in mind that there are two kinds of mutual funds - load funds, which charge a sales commission, and no-load funds. However, charging the commission doesn’t necessarily mean a higher return.

Next, decide on how much risk you can take and check how risky the investments of the mutual fund are. To do this, you need to check the following: the fund's biggest quarterly loss, which will help you brace for the worst; its beta, which measures a fund's volatility against the S&P 500; and the standard deviation, which shows how much a fund bounces around its average returns.

In general, they are not too risky because they invest in dozens or hundreds of stocks. But you can still lose money if you don’t choose a mutual fund carefully.

Large companies are usually more stable during the turbulent periods whereas the mid cap and small cap companies are more vulnerable. It might be best to invest in different fund categories to achieve more distinct risk/reward objectives and thus reducing the overall portfolio risk.

If the mutual fund ranks high over a period of time, it doesn’t mean it will stay on top. Instead, choose a mutual fund with consistent long-term results, total return, and protection of capital. Also, don’t be set off by losers. Every fund has an off year every once in a while, but you should check if it has trailed comparable funds for more than two years. It is time to move on only if earnings have been consistently below par.

The next thing you should do is choose the funds according to the asset allocation. Most investors need just a few funds, carefully picked, watched and managed over a period of time.

Finally, compare the track record with the similar funds, and try to find a good fund manager. Find each fund’s toll-free phone number, so you can call to get information and ask questions. You can also get a free prospectus that explains the principal strategies, objectives, risks, performance and fees associated with the mutual fund.

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