How to choose the right mutual fund for you
It's time to get smart about investing
Graduating college around the time the market crashed and seeing people lose the money they were depending on for retirement made a big impression on me. Suddenly, I became more worried about saving for retirement than saving for a car or a rainy day, and that worry hasn't let up over the years.
With an eye on saving for retirement, I worked to pay off my credit card debt, contributed to my 401(k), and opened a savings account. I knew the next step was investing, but I wasn't sure where to begin — and I didn't want to lose everything I had if the stock market crashed again.
It seems like a lot of people are in the same position as me. According to the Federal Reserve's Survey of Consumer Finances, 98 percent of all financial assets in 2016 were transaction accounts such as a checking or savings accounts. But only about 52 percent of financial assets as of 2016 included some kind of retirement account, like an individual retirement account (IRA) or a 401(k). And participating in bonds and directly held stocks is not common, the Federal Reserve says.
Cherry-picking individual stocks is risky and doesn't get you the best investment results, personal finance adviser Ramit Sethi says in his book I will Teach you to be Rich. Instead, he says investing in mutual funds and index funds, which are a collection of stocks and sometimes bonds, provides much better results. Below are a few ideas to help you choose the right fund for you.
1. Do your homework
There are loads of investment service companies that offer products like mutual funds, exchange-traded funds, and IRAs, similar to how banks offer checking and savings accounts. How do you pick the right one?
It helps to do your homework. For example, Morningstar provides investment research, and its fund ratings can help you decide where to invest. Morningstar uses a five-star system, where funds that perform better compared with similar funds get more stars. But ratings look at the past performance of a fund, which means that it doesn't guarantee that the fund will do well in the future, the Economic Times cautions.
2. Watch out for fees
Mutual funds cost money to manage, and paying attention to the fees you pay now can save you a lot of money later. "You can't control the markets, but you can control the bite of costs and taxes," advises Vanguard in its Principles for Investing Success guide. A management fee is usually a percentage of the amount of money being managed. A fee of 1 percent to 3 percent could equal a small amount of money when you're starting out, but when you grow your earnings over decades, that small percentage can really add up.
Index funds are passively managed, meaning they are automatically set up to match market benchmarks. "They simply and methodically pick the same stocks that an index holds — for example, the 500 stocks in the S&P 500," Sethi writes in his book. The S&P 500 represents 500 large U.S. companies, but there are different kinds of indexes that hold different kinds of stocks. This means index funds are generally cheaper to maintain because they don't need as many researchers or advisers, which in turn means lower fees.
3. Use target-date funds
Target-date funds are based on the age or retirement date of the investor. They typically start out with more aggressive investments — for example, a higher percentage of the fund would be in higher risk, higher reward investments like stocks. But when investors age, a target-date fund gradually invests a bigger percentage of its assets in less risky assets, like bonds. This allows your investment to change over time to suit your needs automatically. "Younger investors, theoretically, can withstand more volatility," says John Croke, Vanguard's head of multiasset product management.
4. Consider sector-based funds
Some funds invest only in certain sectors, rather than diversifying across sectors. "The sector fund may be limited by geography, such as a stock fund comprised of Chinese stocks or by a type of company, such as health-care stocks," writes Barbara Friedberg at U.S. News & World Report. Investing in one sector is usually riskier than diversifying your assets across many sectors because the risk is more concentrated. "Investing in sector funds gives the investor an opportunity to profit from trends," Friedberg says. However, "the disadvantage of investing in a sector is the possibility that you choose wrong."
5. I've invested in a mutual fund — now what?
Your investments may change with your lifestyle and financial goals. How often you check on your investments, meet with a financial adviser, or change the makeup of your investments is of course up to you, but remember that mutual funds are for longer-term investments, so their daily or weekly performance doesn't matter as much as their yearly or decade performance does.