How to Choose Mutual Funds
Beginner Investing and Growing Your Savings
Choosing mutual funds for individual savings goals requires some thought before investing. Discover what to consider and what research to do before choosing a fund.
Mutual Fund Definitions
- Capital: Initial funds put into a mutual fund.
- Capital gains: Profits from stocks sales within a fund which are then distributed to mutual fund holders.
- Capital appreciation: Security values rise with opportunity to sell for profit.
- Reinvest: Dividends, interest or capital gains distributed to a share holder who uses this income to buy more mutual fund shares. Put simply, reinvested gains earn interest on interest.
- Income: The value of an income fund will not grow much, but generates dividends and interest.
- Prospectus: Document with information on fund objectives, fund manager, finances, past performance and other information.
Investment Term
Short-term Investments: If you will invest for one or two years, choose a mutual fund that secures capital while generating some income.
Mid-term Investments: Money invested for two to five years requires a reasonable degree of security for capital along with opportunities for income and perhaps capital appreciation.
Long-term Investments: Higher-risk investments held for over five years which generate higher returns. Long-term investments have more time to recover in the event of a market downturn.
Risk Tolerance
Risk tolerance refers to the level of risk you can personally tolerate while investing, and is different for everyone. Risk tolerance factors include:
- Your age. Applies primarily to long-term investments such as retirement or college savings. Younger people investing early have more time to grow investments while older individuals have less time to realize capital appreciation in a mutual fund.
- Level of disposable income. Disposable income is money not required for living or other expenses. If you have more disposable income available, you can afford a greater degree of risk because you do not need the money for essential expenses.
- Intuitive, "gut" feeling. Everyone has a personal comfort level with the risk vs. reward of mutual funds and other investments. Do not invest in a mutual fund you are not comfortable with, but if you are uncomfortable with even the lowest risk mutual funds, learn more about mutual funds and review past returns to determine if your concerns are valid.
- Savings goals. Two people with five-year savings goals should not necessarily invest in the same mutual funds. The person planning to take a vacation in five years can opt to put the vacation off if a mutual did not perform as well as expected. Another person planning to quit work and become a full-time student in five years needs savings for living expenses and tuition.
Mutual Fund Investment Strategies
These investment strategies assume that you are reinvesting gains.
Capital Preservation Investment Strategy
To preserve capital, invest in low-risk mutual funds such as money market funds or short-term bond funds. While these short-term investment options have lower returns, your capital is quite safe.
Appropriate for short-term investing, low risk tolerance, individuals over 60 years of age and those who can risk no capital loss.
Current Income Investment Strategy
Two options for this strategy are income funds, which provide monthly or quarterly dividends and some balanced funds that provide growth but focus on income.
Appropriate for mid-term investments, moderate levels of risk tolerance or disposable income, and all age groups.
Growth Investment Strategy
Growth funds have a higher level of risk with a better chance of capital appreciation. Growth stocks react more to stock market fluctuations and may have some disappointing years, but well-managed growth funds outperform other types of funds over the long term.
Appropriate for long-term savings goals, high levels of risk tolerance or disposable income and college fund accounts opened before the child reaches teen years.
Learn More!
Mutual Funds: Types and Classification
This article is for informational purposes only and does not constitute specific financial or investment advice.
