How to Choose the Best Mutual Fund

 

How to Choose the Best Mutual Fund

A mutual fund is an investment product that involves pooling the assets of many investors into a pool. The fund then invests those assets in a group of assets to reach its goals.

Identifying Goals and Risk Tolerance

How to Choose the Best Mutual Fund 

Before investing in a fund, you should first identify your goals. This step will help you determine how much money to put aside and how long it will take to pay for college or retirement.

You also need to consider your tolerance for risk. If you can tolerate volatility, then a more conservative investment may be suitable.

Before you decide to invest, consider the length of time that you would like to hold the investment. It's also important to keep in mind that funds have sales charges, which can severely affect returns in the short run.

Style and Fund Type

The goal of long-term capital appreciation funds is to provide consistent and higher returns over time. These funds are typically considered risky due to their high percentage of common stocks. Ideally, they should be held for at least five years.

Capital appreciation and growth funds do not pay a regular monthly income. If you need income, an income fund may be the better choice. A fund that invests in bonds is commonly known to buy corporate debt and government bonds.

These funds tend to have a lower volatility than stocks. They can also be used to diversify your portfolio by investing in bonds that have a negative correlation to the market.

Although it's possible to include bond funds in your portfolio for diversification, there are times when you simply cannot handle the significant risk. A balanced fund could be a good alternative.

Fees and Loads

It is also important to understand the various charges that a mutual fund company may charge its investors.

Some funds charge a front-end load fee, while the back-end load fee is usually charged after the purchase of the shares. These fees are usually higher for the first year, then gradually decline as long as the investor holds the shares.

Front-end loaded shares are identified as Class A shares, while back-end loaded shares are called Class B shares.1

Back-end and front-end loaded funds typically charge around 3% to 6% to cover administrative charges related to the investment. Depending on the type of mutual fund, these fees may be passed on to the broker who sold the shares.

Another type of fee that a fund may charge is called a level-load fee. This fee is typically deducted from the assets of the fund.

No-load funds do not have a load fee. However, they may charge high expenses, such as a management expense ratio. Another type of fee that funds often charge is called 12b-1 fees. These fees are typically charged for the distribution of fund shares.

The expense ratio is the portion of the fund's assets that are being used to cover the fund's expenses.

Passive vs. Active Management

If you are looking for a mutual fund that is both active and passive, then you should consider an actively managed fund. This type of fund has a team of experts that can make informed decisions regarding the fund's assets and securities.

Active funds tend to outperform their benchmark index. However, they usually have higher expenses than their active counterparts.

A passively managed fund is typically focused on replicating the performance of a standard index. It charges lower expenses than actively managed funds.

Since a passively managed fund doesn't trade as much as an actively managed fund, it's not creating as much taxable income as its active counterpart.

There's also a debate about the merits of actively managed funds. According to a report released in 2017, only 16% of actively managed US funds beat their respective index during the past five years.

Despite the low expenses, index funds have failed to beat their benchmarks. This has made them incredibly popular with investors.

Evaluating Managers and Past Results

While it's important to analyze a fund's past performance, it's also important to ask yourself about the fund's track record.

The answers to these questions will help you evaluate the fund's past performance and provide insight into its historical trend.

Before buying a fund, it's also important to read its prospectus to get a better understanding of the fund's strategy and its potential future performance.

Size of the Fund

Usually, the size of a fund does not limit its ability to meet its goals. However, it can also cause a fund to get too big. For instance, in 1999, the Magellan Fund reached $100 billion in assets and had to change its strategy due to the influx of new money.

The size of a fund's assets can make it harder for a portfolio manager to effectively manage it.

History Often Doesn't Repeat

Even though past performance doesn't guarantee future results, many funds have been beating the competition in recent years.

A report released by Standard & Poor's in 2011 revealed that only a small portion of domestic stocks performed well.

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