Anyone who's shopped for a mutual fund knows finding the right one can be harder than locating that proverbial needle in a haystack. There are so many to choose from. Remarkably, people seem to navigate the selection process somehow, because statistics show that most stocks held by the average American are purchased by way of a mutual fund.
Mutual funds do the work for you
"Certainly stock mutual funds provide an easy alternative to chasing after stocks on your own," said Chris Byrne, a financial consultant in Beverly Hills, Calif. "Most working professionals have neither the time nor the skill it takes to make informed stock picks. They buy into a stock mutual fund precisely because they expect high-grade, minute-to-minute surveillance work to be done on their behalf." Fund managers spend their entire working day tracking the market and they don't work alone. Teams of analysts assist them by poring over corporate financial reports and keeping close watch on the firms in which they invest.
"An individual investor would have to quit their job and go back to school for years to gain half the insight and experience of a top-level fund manager," added Byrne.
Mutual funds have much to commend them, not least of which is the instant access they provide to a diversified portfolio. "Even if you have only $1,000 to invest in stocks, it makes sense that owning a small portion of a diversified portfolio is better than owning a personal portfolio containing shares from only one company. This way you're protected from possible fluctuations of that solitary stock," said Byrne.
Know your risk tolerance
Stock mutual funds can be geared toward an investor's risk threshold. The more conservative investor would focus on lower-risk balanced funds that usually are composed of high-dividend-yielding stocks and bonds. A more ambitious investor, one who's not afraid to gamble the principal investment, might consider aggressive growth funds. These are made up of stocks from fast-growing companies which specialists believe have potential to attain major stock appreciation. The investor might likewise invest in financially distressed companies hoping for a turnaround. Obviously, both are risky expectations - if they weren't, everybody would buy them.
Because stock mutual funds purchase in higher volume than individual investors, they occupy a significant presence on Wall Street. And with these funds, the investor saves more on brokerage commissions, thereby increasing the investment's return
. Fortunately for us, companies like Morningstar - the best-known rating guide for mutual funds - exist to supply data on and analysis of mutual funds. More than 8,500 are listed on Morningstar's Web site.
Mutual fund shareholders usually have a choice of what to do with any dividends, interest, or capital generated by the fund. They can either take receipt of the money, or have it automatically reinvested in the fund, which adds to the value of an investment over time.
Mutual funds have many costs
Before signing on to a particular mutual fund, it is best to investigate just how costly it might be. Find out if it's a load or a no-load fund - load funds charge a commission at the time of purchase (a front-end fee), and/or when shares are sold (a back-end or redemption fee). Both load and no-load funds deduct an annual management fee for services rendered by the investment company. And be aware that the 12b-1 Fee, named after the SEC rule it falls under, is deducted once a year to cover promotional, marketing, and distribution expenses.
Most funds charge commissions to reinvest fund dividends, and miscellaneous administrative expenses are likely to appear for accounting, legal, postage, printing, and so on. If there's a transaction to be made for the fund, you can be sure there's a provision in the prospectus - in very fine print - allowing a fee deduction to cover it.
Bill Barker, financial analyst for The Motley Fool, has been highly uncomplimentary toward mutual funds. He said, "95 percent of everything you need to know to succeed in the zany world of mutual fund investing is: buy an index fund."
Barker conceded that mutual funds offer a few advantages - such as diversification and liquidity - but beyond that, "The average mutual fund manager provides stock picks no better than the average nonprofessional, dart board, or stock-picking hamster, as far as we can tell. Annual fees charged by the well-dressed mutual fund manager, however, are significantly more than what it costs to feed a hamster." At the end of the day, he said, "a mutual fund denies you control of your own money…(it) puts you in the passenger seat of somebody else's car."
- Audrey Arkins, Salary.com contributor