6 Things To Ask Before Investing in Mutual Funds

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Investing in mutual funds can be a great way to grow your wealth.  A mutual fund, at its core, is an investment that pools money from a wide variety of investors and uses that money to buy a variety of stocks, bonds or short-term debts.

The mutual fund is a great investment option because of the variety of profit sources within the fund, but there are questions you need to ask before choosing which mutual fund to invest in.

What is the expense ratio?

An expense ratio of an investment refers to the total percentage of money used annually to cover management expenses of the fund.  This includes management costs, advertising costs and administrative costs. The costs used to manage a mutual fund cut down on the amount of profit investors receive, so it’s important for investors to understand this number before investing.

The largest expense a mutual fund incurs is often the fee paid to the mutual fund’s manager/advisor.  A high expense ratio could indicate an overpaid advisor.  Expense ratios will differ depending on the type of investment you’re researching, but an acceptable expense ratio in today’s world will generally be under one percent. But you shouldn’t even be paying that much. Consider the lowest cost options on Clark’s investing guide. You can also use a free tool like Person Capital to analyze all of your investments to see exactly what you are paying in fees for your investments.

How long has the fund manager been around?

The mutual fund manager of a particular fund will be responsible for determining which securities to purchase, which to sell and how to retain balance and profit within the fund based on his/her education and experience in the industry.

As size and structures of mutual funds differ, so does the management of those funds.  Management of some mutual funds is done by a team, while other funds have a sole manager at the helm. Experience of the fund manager is vital to the success of a fund, but so is that manager’s history.  When researching a mutual fund, it’s important to look at the number of years the fund manager has been operating the fund, along with the coinciding performance history of the fund. 

Based on the manager’s history of managing a particular fund, look at how they handle market storms.  Is the fund manager a trend-chaser, or do they take the time to research a move before they make it?  A long-term fund manager doesn’t guarantee success, but most fund companies won’t keep a poorly performing fund manager around for long.

What has the performance of the fund been over the past 10 years?

It’s vital when choosing a mutual fund to check the performance history of the fund.  Has profit been steady and stable over the past 10 years?  Was profit poor at first, but in the last few years has seen an increase? If so, why?  Was a new, more experienced fund manager placed on the team?  Before choosing a mutual fund to invest in, research the performance history and see if the investment still makes sense and falls in line with your personal investment style.

Am I paying a “load”?

A “load” mutual fund charges investors for the shares and units they purchase, and often adds an additional fee on top of that charge. The charge can be a percentage-based charge or a flat fee, depending on the fund. A “no-load” fund means that you can buy and sell shares without paying a commission or fee.

There are varying opinions on whether or not it’s wise to buy a load fund. It’s up to the individual investor to determine whether or not a load fund is right for them. But it is important for every investor to know whether or not the fund they’re considering will be a load or no load fund, so that no unexpected fees are reducing their profit margin.

How risky is the fund?

Determining the risk within a mutual fund can be tricky, but educating yourself on investment risks before you put your money on the table will help you figure out whether or not a particular mutual fund investment is right for you.

When you are younger, you can take on more risk because you have a longer time horizon to invest. However, when you are older you want to preserve your capital, so it makes sense to invest in funds that are more stable and that have less risk. When investing in mutual funds, you need to keep in mind what your time horizon is, as well as what your risk tolerance is, and then invest accordingly. One of low cost leaders, Vanguard, has a helpful “risk potential” rating on their funds. This can be a really helpful tool.

Will the fund help you achieve your long-term financial goals?

In order to determine if a mutual fund will help you achieve your long-term financial goals, you must first know what those goals are.  While it is possible to determine these goals on your own, you may also want to consider meeting with a Financial Planner to create a comprehensive financial plan so that no details are left out.

After you have a clear picture of what your long-term investing and financial goals are, you will be better able to determine — based on a particular mutual fund’s long-term performance history — if the fund you’re considering has management values that fall in line with your long-term financial goals.  Mutual funds are not meant to be a short-term investment option, so this step is vitally important to choosing the right mutual fund.

Conclusion

An educated investor can make a nice return on a mutual fund investment, provided he or she has done their homework and knows the keys to determining if a particular mutual fund is a smart choice for their particular investment goals.  By researching the mutual funds you’re considering thoroughly, you have a better chance of picking the mutual fund or funds that are right for your portfolio.

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Deacon Hayes About the author:
Deacon Hayes is the founder of WellKeptWallet.com which helps people get out of debt in a short period of time. Follow him on Twitter.
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