Mutual funds represent the simplest and most accessible way for novice investors to start building their portfolio. Even for more sophisticated investors, mutual funds form the core of their portfolio as they provide diversification and often market returns. That said, there are thousands of different mutual funds out there, and many people become frustrated and overwhelmed when trying to pick the one that’s right for them. Here are five fundamental questions you can ask yourself to narrow down the pool to find the funds that fit with your financial goals:
What Is My Risk Tolerance?
Before you begin selecting mutual funds, it is important to figure out your risk profile. Investing is inherently risky, regardless of what asset class you are investing in. Some investments are safer than others, and it is essential to select investments that correspond with your financial objectives. While figuring out your appetite for risk, you should consider the following:
- How knowledgeable am I about investing? You have to develop a degree of comfort and understanding of what you are investing in. Far too many invest in vehicles they don’t grasp, and end up being exposed to more risk than they would like.
- What is my time horizon? Most retail investors are focusing on the long haul, either retirement or buying a home. Achieving these objectives require well- diversified strategies with a mixture of asset classes.
- How much in savings do I have already? The amount you already have socked away plays a big role on how risk-averse you should be with your future investments.
After determining your risk profile, what are the most important criteria to consider?
What Does The Fund Charge In Fees?
In general, actively managed funds tend to charge higher fees than those that are pegged to an index. If possible, it’s best to buy into funds that are passively managed, because fees can seriously cut into your investment returns. If you’re concerned that a passively managed fund won’t perform as well as one that tracks an index, don’t worry. Studies show that only 24% of actively managed funds beat the returns of the overall market.
What Is The Fund’s Strategy?
Most index funds offer fairly general, market-mimicking strategies. While these funds are long-term oriented and certainly belong in your portfolio, you can also choose to invest behind certain sectors or trends. Often, these funds are actively managed, and should not form the core of your portfolio. That said, for more sophisticated investors that have a higher risk tolerance, opportunistically investing in a sector or strategy that you think will perform can be considered. Be sure to keep in mind the fee load and make sure that the background and expertise of the individual fund manager corresponds to the fund strategy.
How Has The Fund Performed In The Past?
Past performance is in no way a guarantee of future returns. However, if you’ve narrowed down the funds you’re considering by risk tolerance, fees, and management, it’s time to start looking at how the fund has performed in the past 10 years, especially in comparison to similar funds. If you find that any of the funds on your short-list are underperforming their counterparts or worse, aren’t matching the returns of the overall market, scratch those funds off the list.
Do The Underlying Assets In The Fund Support My Values?
If you have strong convictions about political or social issues, the idea of putting your money into a mutual fund that invests in companies that act in ways that are contrary to your values might be troublesome. Luckily, there are mutual funds that invest specifically in companies that support certain interests. For example, you can invest in funds that only have exposure to companies that have a proven track record of supporting environmental and social initiatives.
The takeaway : While selecting the right mutual fund might initially seem tricky, with the right information, you’ll be equipped to find the one that’s right for you and your financial goals.
Joseph Egoian is an analyst at Nerdwallet, a website focused on helping consumers make better financial decisions, whether it’s to help them find the best credit card for their needs, or to find the right online brokerage account