How to Choose a Mutual Fund

how to choose a mutual fund

Some investors like picking stocks and investing in specific companies. There’s nothing wrong with that. But investing in mutual funds is a popular way to invest in many companies at the same time. There’s often less volatility than when buying one company’s stock because the risk is more broadly spread out over a number of companies.

It can be confusing to pick a mutual fund, though, which is one reason a financial advisor is a good person to have on your side for these important financial decisions. Once you have an advisor, and have determined your goals and risk tolerance, it’s time to talk about mutual fund choices. Each financial company offering mutual fund investments has a plethora from which to choose. How do you choose the right mutual fund for you and your portfolio? Here are five handy ways to consider picking a mutual fund, once you and your financial advisor have determined your goals:

Pick a sector

If you are interested in technology, precious metals, real estate or healthcare, for example, there are mutual funds targeted to them specifically. Focusing part of your investment on one sector is considered higher risk since some segments rise and fall depending on the economy. Investment advisers typically don’t tell clients to put all their money in one sector for this reason.

Some investors prefer to invest in mutual funds in several sectors to balance out the risk. Sector mutual funds tend to have a higher turnover of companies within the fund, which may prompt more capital gains taxes for the investor. Proponents of sector-based funds like the potential for higher returns and investing more broadly in companies in a specific field. Ask your financial advisor’s thoughts about including sector investing in your plan.

Are you a risk taker?

Each mutual fund has a risk profile, disclosed on the prospectus. Investors with a higher risk tolerance might choose more aggressive funds. These funds often have higher returns than other funds, but they’re also at risk for greater losses. Other investors want to preserve their money and grow it more slowly in exchange for a less risky investment.

One way to consider your risk tolerance is to think about when you may need access to the money. If you’re retiring in a few years and relying on your mutual funds for living expenses, you’ll be less interested in an aggressive fund than someone in their 20s who has a wider window to ride out the market’s highs and lows. A financial advisor will help you develop a plan based on your age, when you need the funds and your risk tolerance.

Age-based funds

Age-based funds, also called target-date funds, are a good way to balance a portfolio without having to allocate investments in mutual funds, bonds and cash. Pick a fund based on your expected retirement year, and the fund manager adjusts the mutual fund mix accordingly.

If you invest in the fund when you’re younger, the investments will be more aggressive because there’s more time to ride out market fluctuations, and the growth overall should be higher. As it gets closer to the retirement date, the mix becomes more conservative with a higher percentage of investments in bonds and cash. Speak with your financial advisor about an age-based fund option.

Index funds

Many investors prefer taking a market approach, mirroring a specific stock market to get the benefits of a balanced stock portfolio without the hassle. An index mutual fund includes all stocks in the index it’s modeled after, such as the Standard and Poor’s 500 or the Wilshire Total Market Index. There’s no mystery about what stocks are in the fund.

One advantage of index investing they generally have lower management fees. Since the fund isn’t actively managed but just shifted based on actual index changes, fees are often less than actively managed funds. One disadvantage is you’re not going to beat the market performance rates, since the fund is basically the same market ratio.

Pick a company you trust

With so many mutual funds available, one way to narrow the list is by only investing with financial companies that you trust. The companies should have a good reputation and keep management fees reasonable. Once you find companies that meet these criteria, it’s easier to choose from their mutual funds given your investing preferences.

Click here to learn more about finding a financial advisor who can help you get started with mutual funds.