A Guide To Choosing Mutual Funds

Once you decide to invest some of your hard-earned money into mutual funds, a simple plan of attack will help you make a profitable decision. Before buying fund shares, you need to identify your investment objectives and conduct some research. After you purchase mutual fund shares, you'll want to monitor their progress periodically.

OBJECTIVES

Consider your investment goals. How will this money be used? When will I need it? What kind of risk can I tolerate? How much money do I want to invest? Before you invest in a mutual fund, you will need to answer these questions.

Your investment time frame is a big factor in your final decision. How many years do you have before your goal needs to be met?  If the money is intended for retirement, your time frame is likely to be much longer than if the money is intended for a down payment on a house.

The longer the time frame, the greater the risk you can endure, because you're more focused on long-term results, not short-term volatility. For a long-term investment, consider stock, equity funds, long-term bond funds, or even real estate funds.

If your time frame is shorter, you'll need the money comparatively soon, so you won't want too much risk. Volatile price jumps can wreak havoc on the short-term plan. Focus on relatively low-risk investments such as money market mutual funds or short-term bond funds.

Of course, it's important to know how much money you have to invest. Most mutual funds have a minimum investment amount. However, several funds allow monthly installments, many of which can be set up to withdraw directly from your bank account.

There are advantages to investing your money over a given period. If you invest a set amount of money each month, you are taking advantage of the dollar-cost averaging effect, which means that you will buy more shares when the price is lower and fewer shares when the price is higher. Over a long period, this can increase your returns.

Once you have an idea of your investment time frame, risk allowance, and investment amount, you can start to think about the types of mutual funds that will meet your goals. There probably won't be one all-encompassing fund that meets all of your needs, so you may want to consider a collection of funds. For example, to limit your risk you could put 60% of your money into stock funds and 40% into bond funds. Or you may want to consider a balanced? mutual fund that invests in both stocks and bonds. This type of asset allocation is important when choosing a mutual fund or portfolio of funds that works best for you and your needs.

When you feel comfortable with your investment objectives and you've weighed your options for asset allocation, you can move on to the research phase of your plan.

RESEARCH

Research can be time-consuming, but it pays off in the long run. After looking at your objectives, you may decide that for your long-term investment, you are going to invest most of your money into stock mutual funds. That's great, but what class of fund and what style are you going to choose? At this point, you'll want to educate yourself on the differences between small-cap funds and large-cap funds, international and domestic, value and growth, and so on. A wealth of information can be found on the Internet. Again, you must make sure that the mutual fund you buy is in tune with your investment objectives.

For any fund you consider, you should be well aware of the fees involved. Expense ratios, loads, turnover costs, marketing fees, management fees, and taxes all eat into your profits. These losses compound as the investment grows over time. The safest bet is to buy a no-load? mutual fund with a small expense ratio -- say, less than 1.25% for a stock mutual fund.
 Be sure to check out the fund management. After all, in most cases, the manager makes some of your investment decisions, so you'll want to know something about his or her background. A brand-new manager may not be as reliable as one who has been working with a specific fund for many years.

Fund performance is a difficult criterion on which to base an investment decision, mostly because past results cannot guarantee future performance, especially in shorter time periods. When looking at performance records, it may help to focus on the consistency of the results over a longer period. What do the five- and 10-year rates of return look like?

You can do most of this research simply by obtaining the mutual fund's prospectus?. The prospectus contains information about the mutual fund's objectives, investment strategies, expenses and fees, manager bios, and performance statistics. Prospectuses are often available through a mutual fund company's website, or you can call the company and request one. This also gives you a chance to test the customer service. Are your questions answered knowledgeably?  Are you placed on hold for a long time? This sort of information can definitely affect your final decision.

When the research phase is complete, you should be ready to purchase a mutual fund or portfolio of funds. Once you understand what's available, you can make a confident, educated decision.

PURCHASE

You can buy shares of a mutual fund several ways: buy directly from the fund company, buy from a broker or financial planner, or obtain shares as part of your retirement or 401(k) account.

Many fund companies will allow you to open an account with them directly. You can call to request an account form or find a form on the company's website to send in. This is a direct, easy way to purchase fund shares.

If you already have a brokerage account, full service or online, you can probably purchase mutual fund shares and obtain prospectuses directly from your brokerage. Here's something to watch for -- you may pay transaction fees to the brokerage for buying or selling mutual fund shares. For example, TDWaterhouse offers more than 10,000 mutual funds through their online brokerage accounts, 1,400 of which can be bought with no transaction fee.

If you are trying to determine which mutual fund in your 401(k) or retirement account to invest in, you can place a call to the plan provider to allocate your funds. Some providers also offer the ability to choose and reallocate funds on their websites.

Once you've purchased your shares, sit back and watch your money grow. Check on your investments periodically, though, to make sure that everything is still in line with your goals and objectives.

MONITOR

It's fairly simple to monitor your investments, and you only need to do it once in a while. Watch the performance of your investments. Make sure the fund's objectives remain the same and still mirror your own. In addition, watch for changes in management. If the fund brings in a new manager who has little experience with your fund class, then you may want to consider switching to a new fund. As your goals and objectives change, you want to make sure that your investments reflect the changes.

Take a little time to identify your investment goals, research mutual funds, and monitor your investment -- you won't regret the extra effort. Your reward? You just increased your chances of picking a successful mutual fund. If you meet your goals in the time frame you allocated, that's a winning investment.

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CHOOSING A MUTUAL FUND

Selecting a mutual fund from the thousands available can be a daunting task, but this guide will help you narrow your choices. Here's a quick overview of the steps involved:

1. OBJECTIVES

• Goals. What is the money going to be used for?
• Time frame. When will the money be needed?
• Investment amount. How much money do you want to invest?
• Asset allocation. What types of funds match your criteria?

2. RESEARCH

• Fund class and style. Which will meet your objectives the best?
• Expenses and fees. Understand the costs associated with the funds.
• Management. Does the fund manager have ample experience?
• Performance. Look for consistent long-term returns.
• Prospectus. Most of your research can be done by reviewing the fund prospectus.

3. PURCHASE

• Buy directly from fund company.
• Buy from a brokerage.
• Obtain through your 401(k) or retirement account.

4. MONITOR

• Fund performance.
• Fund objectives.
• Fund management.
• Your own objectives.



--S.M.

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RELATED READING
Kim, Han [2001]. "Prospectus Hunting," Working Money, Volume 2: January/February.
Penn, David [2000]. "Reduce Your Risk Of Buying High," Working Money, Volume 1: November/December.