Investing in mutual fund isn’t something that requires the skills of a rocket scientist. However, it can be daunting and overwhelming if you’re not sure which factors to consider when starting out. Read more about mutual funds here to learn how to choose wisely.
Before investing in any kind of mutual fund, or in any instrument, for that matter, you must be clear on what you want to achieve and the amount of risks you can take on for the amount that you want to invest.
Think about whether you want to prioritize your long-term capital gains or your current income. Check whether you have to use the money for your college expenses or you want to fund your retirement.
Isolating your goals is one of the most useful ways to narrow down the list of the thousands of mutual funds available out there.
You also have to consider your personal risk tolerance. Are you ready to bear dramatic swings in your portfolio value? Do you think you are better off with a more conservative portfolio? The risks and returns are directly proportional and you must balance your desire for returns against your ability to tolerate risks.
You should also determine your time horizon. How long would you like to hold an investment? Are there any liquidity concerns for you in the near future? There are sales charges in mutual funds and those fees can eat away from your return over short periods of time.
Style and Type of the Funds
The main goal of growth funds is capital appreciation, which means if you plan to invest to meet a longer-term need and can handle risks and wild swings, you might be better off with a long-term capital appreciation fund.
Most of these funds hold a high percentage of their assets in common stocks and are usually considered more volatile in nature. Because of the higher level of risks, they provide the potential for greater returns over time.
The time frame for holding this kind of mutual fund should be 5 to 10 years at least.
Meanwhile, if you want some regular income from your portfolio, you may want to consider an income fund. Such funds usually hold bonds and other debt instruments that pay interests regularly. Government and corporate bonds are two of the common holdings of bond funds.
These funds carry lower volatility are generally considered less risky. That being said, there still are some inherent risks, including:
- Interest rate risks – sensitivity of bond prices to the changes in interest rates.
- Credit risks – the risk of an issuer having his/her/its credit rating lowered.
- Default risk – the risk that the bond issuer defaults on his/her/its debt obligations.
- Prepayment risk – the risk of the bond holder paying off the bond principal early to take advantage of reissuing its debt at a lower interest.
Charges and Fees
Mutual fund companies earn their keep by charging fees to the investor. It is important to understand the different types of fees associated with an investment before you make a purchase.
Some funds charge a sales fee usually referred to as a load, which will either be charged at a time of purchase upon the sale of an investment.
A front-end load fee is given out or paid out of the initial investment. A back-end load fee is charged when you sell your shares in a fund, and it typically applies if the shares are sold before a predetermined time period, commonly five to 10 years from the purchase.