We have all heard the advantages of investing in a mutual fund over trying to pick out individual stocks. First, mutual funds hire professional analysts who are experienced in the market and spend many hours studying various stocks. Unless you want to spend a large amount of your free time studying financial reports, you probably won’t have as much information to make a decision as a mutual fund manager.
Then there is the well-documented diversification feature. Risk is reduced by holding multiple unrelated investments. Simply put, some are going up, some are down, and they combine performance levels with volatility or risk.
Finally, a mutual fund offers small investors an opportunity to invest in small increments rather than having to spare a large amount of cash to buy 100 shares.
Given the benefits listed above, it is no wonder that mutual funds have become an extremely popular form of investment. There are now thousands of mutual funds to choose from, so how do you choose? Here are some tips:
1. Do not be affected by your jumping to the most recent performing Fund. It may sound safer and more rational, but like individual stocks, you want to buy low and sell high, not buy high and call for more growth.
2. Even good funds may not be able to overcome market strength in general. You should be looking for funds that can outperform the overall market without increasing the risk. Each fund has specific risk criteria that you must follow. Read the leaflet carefully to understand what it is.
3. Determine how much money you have. Unless you are simply trying to achieve the same returns as the general market, diversifying into several mutual funds will not reduce your risk or increase your returns much.
4. Funds that become too popular and too large tend to lose performance. There are many reasons for this.
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A final point to consider is that the type of fund will depend entirely on your investment goals. There are some funds that are designed to achieve your goals, be it retirement, income, growth, college funding, etc.