There are thousands of mutual funds to select from, each offering different investment goals and levels of risk. When making your selection, be mindful of your own investment objectives and time horizon when identifying an appropriate fund.
While it can be tempting to judge a fund solely by how well it performed in its recent past, experts advise focusing on long-term performance instead.
Diversification
Diversification refers to the practice of investing across multiple asset classes, geographical regions and industry sectors to reduce your exposure to risk and enhance long-term performance. Though diversification helps spread your investments across a range of assets and regions, it cannot guarantee against loss if one investment experiences a sudden downturn.
Diversifying your portfolio when investing is of vital importance, whether that means individual stocks, exchange-traded funds or mutual funds. Each asset type comes with different risks and potential returns – and diversifying with both large, midsize and small-cap companies as well as foreign and domestic firms is essential to mitigating risk and managing investment portfolios effectively.
Diversifying within an industry can increase your odds of striking it rich, but beware that doing so comes with its own risks. For instance, investing in railroad stocks may shield against negative changes to airline stocks while possibly harming you if consumer spending shifts towards streaming services instead. This type of risk is known as systematic and can’t be eliminated through diversification alone.
Taxes
Mutual fund investment can present both tax benefits and obligations depending on how you hold your shares. For example, investing in a taxable brokerage firm account could lead to capital gains when the fund sells securities at a profit – these gains would then be subject to your individual tax bracket and tax rates.
Mutual funds that sell securities at a profit must distribute any gains to shareholders through distributions, which typically occur near the end of every year and include dividends, capital gains and other sources of income. When this occurs shareholders will receive IRS Form 1099-DIV detailing these distributions.
Selecting mutual funds with lower turnover ratios may help lower your taxable liability by limiting how often capital gains taxes need to be paid; however, this strategy isn’t always successful.
Liquidity
Liquid funds offer investors who require access to their funds quickly a good choice; however, all mutual funds carry some degree of investment risk; the price of securities could fluctuate, as could dividend or interest payments, and ultimately principal value could decrease on shares held within them.
Liquidity risk analysis involves considering the timeliness and cost associated with selling assets or classes of assets on an asset market; also including whether funds can satisfy redemption requests without selling off unsuitable investments.
Most open-end mutual funds and ETFs must hold at least seven days’ worth of redemption proceeds on hand for redemption purposes; some exceed this requirement due to SEC requirements that a certain percentage of their assets must remain liquid.
Funds typically gain cash on an ongoing basis through investor purchases of new shares and interest/dividend payments they reinvest. This cash may then be used to manage portfolio liquidity and satisfy any unexpected redemption requests that arise.
Fees
Operating a mutual fund incurs costs. Funds pass these on to investors through fees and charges; this expense ratio includes expenses such as 12b-1 fees (to market the fund to potential investors) and management fees.
Some funds also incur fixed costs such as rent or audit fees that will remain the same regardless of their asset size, such as rent.
Front-end sales loads (FESLs) are fees payable when purchasing mutual funds. Certain fund companies offer reduced front-end sales loads if investors invest in their fund within certain time frames (known as breakpoints).
Some funds offer different share classes with different fees attached, with institutions like employer-sponsored retirement plans often being able to negotiate lower fees than individual retail investors who pay more in fees. When entering the year of conversion for your fund, enter this amount so as to calculate total operating expenses post conversion.
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