When shopping around for investment products, there is an array of choices to select from, one of which is a mutual fund. The market is full of mutual funds, which are organized and managed in a variety of ways to fit individual portfolio needs. Before selecting a fund for your portfolio, it is important to learn how mutual funds work and how a mutual fund may apply to your life.
Mutual Funds: To Manage or Not to Manage
When you choose a mutual fund, the money you invest in it is taken up by a money manager, who makes it their job to manage the portfolio of stocks, bonds, real estate and other types of securities to create returns on the investments and manage risk. It is the fund manager’s job to ensure that the fund is constructed well and properly diversified. Choosing just one mutual fund can save you many hours of research constructing that diversity in your own portfolio.
If you select a mutual fund for a portion of your investments, you want to make sure it is composed of good investments. Given the choice between an actively managed or passively managed fund, which do you think is a stronger investment? The word “passive” can have a negative connotation, bringing to mind a manager sitting idly by while the fluctuations of the market wreak havoc on your savings. When we look at the statistics, however, the exact opposite turns out to be true.
The more effort fund managers put into choosing their investments, the more susceptible to loss the funds become. Uniformly over time, passively managed funds tend to weather the fluctuations in the market and end up outperforming actively managed funds. What’s more, their internal management fee is generally less than an actively managed fund. So, why are people still choosing active mutual fund options when they appear to be riskier, pricier, and perform worse statistically?
The answer is relative and relates to how mutual funds work. We can compare the variety of funds out there to vehicle parts. All vehicles on the market feature wheels, axles and an engine—but they differ in many other ways. You will need to look closely at your specific needs to see which model of vehicle matches your lifestyle best. Likewise, you must look at the specific needs of your portfolio.
Diversify?
Let’s say you have chosen a passively managed fund. The question now is, which passive fund? Many of the general web resources out there make it seem like as long as it is passively managed, it does not matter. If you’re still working and not solely dependent on the income, this may be true to an extent. But if you are living off the capital in the account, it absolutely matters which fund you choose, and when you choose it.
Timing is a serious factor when we consider the type of fund to buy when markets are high. Think of it this way: “Who would like to buy the most expensive house, in the most expensive neighborhood, at the most expensive time?” This is what we want to avoid doing with an investment. When you’re assessing a fund, not only do you need to look at details of the fund, but the market context as well. All mutual funds come with a prospectus, which explains the rationale of the fund, any inherent risks, and hopefully a good amount of market data. It is crucial to review this document before making any big commitments.
When it comes to how mutual funds work, it is the details that need to guide your choice. You’ll want to inform yourself of the specifics of the product you are looking at, certainly, but just as importantly, you want to be aware of the specific needs of you and your loved ones.
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