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You're an experienced investor and already realize what a powerful investment vehicle mutual funds can be. You find comfort in the fact that mutual funds are professionally managed and your investments are diversified. In fact you may already have an Index Fund or two in your portfolio…but you have some extra money and want to invest in something different – maybe a fund in a hot sector like technology or telecommunications. Picking an index fund was a "no brainer", but how do you find the best mutual fund for you? Even in specialized sectors, there is a buffet table of funds to choose from. You'll need to learn how to pick through the fat to get to the meat. Here's how to do it.
I may be speaking to the choir, but before you start looking at annual rates of return and manager track records, you need to determine your investment objective, investment time frame and risk tolerance. Are you willing to risk some of your capital for the potential of a very high annual rate of return? If you have money invested in a highly volatile mutual fund, can you sleep soundly at night? Are you looking for a good steady return over the next 20, 30, 40 years or will you need the money within the next five years? Developing a clear cut investment plan is crucial to the selection process. Remember, be brutally honest with yourself so you can sleep better at night.
To match your desired rate of return and risk tolerance, there are several different fund types varying from very aggressive like small cap funds to very conservative like money-market funds. From this list, you can find a fund to best meet your investment needs.
Aggressive Growth Funds
These funds generally consist of small cap companies, emerging industries and volatile securities. The fund managers may also use speculative techniques, such as short selling, to generate higher returns and may stay fully invested most of the time. Of course, along with higher returns comes higher risk. Aggressive growth funds are better suited for individuals with long-term investment horizons and must be closely monitored for any potentially adverse changes like new fund managers and a pattern of losing quarters.
Specialized or Sector Funds
Specialized funds focus their investments in one or possibly two industries or sectors: such as technology, financial, biotechnology and utilities. Although certainly more diversified than buying a couple of related stocks, you lose some of the benefits of diversification found in other funds. However, if you happen to pick a hot sector, your returns will surely be higher, but the wrong sector could be deadly to your investment portfolio. Specialized funds can be a safer alternative than trying to pick the best stock in a hot sector, especially if your prediction goes awry.
Growth Funds
Although less aggressive than its big brother, the Aggressive Growth funds, these funds also strive for high returns through capital appreciation rather than dividend income. Growth funds have a mixture of small, mid and large cap stocks sprinkled with some more conservative securities like preferred stock and bonds. Growth funds will typically yield you higher returns over the long-term and are a good addition to most long term investment portfolios.
Growth and Income Funds
Here the investments may be designed to return a higher level of dividend income. Greater emphasis is placed on capital preservation and developing a strong steady return through bonds, preferred stock and high yielding common stocks like utility stocks. Built for more conservative investors with shorter time frames, Growth and Income funds can give you a good solid return, albeit lower than the Aggressive Growth and Growth funds, and also allow you some capital appreciation through growth stocks.
International and Global Funds
Another way to increase you diversification is through International funds. Although these funds are based in the United States, they invest in companies traded on foreign exchanges. If you like the international flair, but would like to keep one toe in the U.S. Go Global. Global funds, unlike international funds, can also invest in U.S. securities. The international aspect of your investment portfolio can help during times when the value of the dollar is falling, because some of the funds holdings may be denominated in a stronger foreign currency. Also certain countries may be experiencing a very robust economy, such as Asia in the early 1990's and why not ride on the coattails of success.
Bond Funds
I don't need to bore you High Impact investors with the intricate details of Bond funds, because it's obvious, but remember these funds may play a crucial role in your investment portfolio depending on your time horizon. If you have a shorter investment time frame and need the money for a specific event, such as buying a house or college education for your children, you can ill-afford the market's normal ups and downs. Murphy's Law says your investments will be down at the very moment you need the money. So it may be best to utilize fixed income vehicles for those "special needs" type dollars.
Money Market Funds
Money Market funds can be used to set aside emergency money. Although very safe, the yields are not much higher than your savings account, but are almost as liquid.
The above categories are universal to most rating services for mutual funds and can be utilized to narrow your search to one or two fund types. Once you have identified the fund type that matches your carefully thought out investment plan, you are ready to begin the selection process.
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