Choosing a Mutual Fund - Guide to Mutual Fund Investment

Finding a mutual fund that’s a good fit for you can seem a daunting process. After all, there are literally thousands of these things floating around. And if you pick up a financial magazine in hopes of sorting through this mess, you’re bombarded by a ton of fund advertisements, all touting that particular fund family’s great returns and often including pictures of the fund managers, arms crossed and looking fiercely insightful. (Why fund companies think how their managers look is somehow enticing to investors remains a mystery to me.)

Instead of choosing mutual fund by all the fabulous numbers being thrown at you, turn the process around. Start by assessing where you are and what you want to achieve with the money you’re investing. Here, an old maxim of money remains partially true. As we discussed earlier, the younger you are and the longer you have to invest, the more aggressive you can afford to be with your decision; again, the power of time to smooth out volatility is that much more in your favor. So if you’re single and just turned 20, you can look at funds that are a good deal more aggressive than can, say, a 35-year-old who’s married with three kids.

But don’t lose sight of your goals, something that may have little to do with your age. Simply put, what do you want to do with the money once you need it? Purchasing a house? Use it for retirement? Take a once-in-a-lifetime vacation? Each of these targets has a decidedly different time frame, which, in turn, dictates what sort of investment best fits. Again, the further away the goal, the more aggressive you can afford to be.

Equally important is your own psychology. You can hear every argument about diversification, time frame, and volatility until your head is ready to explode, but the fact remains that you have to be comfortable with the decisions that you make. Never, ever make any sort of financial decision that rubs you the wrong way. First off, it’s impractical. If you’re not brutally honest about what sort of fund you’ll be comfortable with, you may be working against your best interests. To illustrate: In the early 1970s, investing $10,000 in an aggressive growth fund may have seemed a horrific choice. Chances are you would have lost half that money during that decade. But that same $10,000, if you had allowed it to stay in the fund, would probably be worth more than $150,000 today. The question is, would you have been able to stick with the fund long enough to ride out the rough spots? If your answer is no, that’s a pretty good argument for looking at funds that are not as prone to those sorts of ups and downs you’re more likely to stand by them.

The second reason not to choose a fund that doesn’t match your emotional makeup is that the stress simply isn’t worth it. If there’s anything I’d like to get across with this article, it’s this: However important informed and sensible money habits can be, they are not the end-all to life. Handling money is a tough enough job sometimes without losing sleep because you’re investing in a fund whose highs and lows are driving you nuts. An extra point or two of return is too costly when it comes at the expense of worry. Go with a more stable choice and chill out.

That being said, here’s a rundown of the some major types of stock mutual funds from which you’ll be able to choose, along with a few suggestions of which ones fit various sorts of situations. Bear in mind, however, that mutual fund names are rather mercurial. Fund families can slap almost any sort of name on a fund, whether or not it accurately reflects how the fund works. Although we’ll be discussing various categories of funds, it’s essential that you go beyond mere names to investigate a fund before investing, as its name may be misleading. More on this later:

Aggressive Growth Funds

If you liken mutual funds to cars, these would be the Formula One models. They’re high-powered and can achieve great results but are also the most prone to breakdowns. Aggressive growth funds generally invest in stocks from companies that really have a chance to take off, such as small companies that are developing products and services that, the management hopes, will be in great demand in the future. The downside, not surprisingly, is that aggressive growth funds are generally the most volatile of all types of funds. Since they’re putting their money into companies that may succeed big-time or fail just as spectacularly, they tend to rise and fall in price with just as much bravado.

Good Fit: Investors who are taking a long-term perspective with their money. While these funds take a sort of ”come home with your shield or on it” approach, they can be the biggest winners, provided you’re willing to stick with them over the long haul. They make a great choice for young investors for something such as an IRA or other retirement account.

Bad Fit: Investors with a shorter time frame say, someone trying to piece together a house down payment in the next five years should steer clear of these. That amount of time simply isn’t long enough to smooth out the bumps. Likewise for investors who don’t have the stomach for what can prove a rough ride again, if things get too crazy and you sell out, all you’re doing is working against yourself.

Growth Funds

These are like aggressive growth funds but with a bit less adrenaline pumping through their veins. Like aggressive funds, these funds are looking for growth opportunities, but they tend to go with more stable, established companies that, while showing plenty of potential for further growth, have more of a track record in place. Growth funds’ returns may not be as high as those achieved by some aggressive funds, but the fall off the cliff isn’t so steep if things go sour.

Good Fit: These funds are a solid choice for long-term growth, even with their slightly more conservative bent. They’re particularly suited to investors who want long-term growth potential but haven’t the stomach for the wild ride proffered by more aggressive funds.

Bad Fit: More stable they may be, but growth funds do carry a fair degree of risk. So these aren’t the gig of choice for investors who are skittish about any sort of risk.