Choosing to invest in mutual funds is a great strategy for generating extra income or saving for retirement or kids’ college. There are many things to consider and lots of tools available for evaluating mutual funds, and finding extra money to fund your funds. Here are some tips on getting started with mutual funds.
Photo courtesy of David Goehring
Your investment philosophy is the way you will invest based on your risk tolerance. Your risk tolerance will vary from ultra-conservative to very aggressive. A person with a conservative investment philosophy will lean towards investing in safer funds, and forgo a potentially higher rate of return for less volatility. The way I explain people to invest is to measure their financial strategy based on their sleep. If they aren’t getting enough sleep because they’re worried about how aggressive their funds are, its time to take it down a notch. Likewise, if they’re losing sleep because they know a fund is great, go for it…but not without sound research.
2. Do Your Mutual Fund Research
The Internet is vivid with wealth building information. You can learn about market trends, mutual fund health, and investing tips that will benefit beginners and experts. One site that I like is Motley Fool, which makes learning about investing fun and normal. It uses plain English, and explains hard terms in words even the beginner can understand. Plus the writers are really clever and you can get a daily chuckle even from learning about hedge funds.
3. Avoid Funds with Excessive Fees
Mutual funds either charge an upfront fee, or a back end fee, and they always charge a 12b-1 fee. Front-end load funds are sold by stock brokerage firms, banks, and financial planners and charge an upfront fee which is the commission to compensate brokers. This commission is 3-8.5% and is sliced off the top of the amount you are investing. After you place an order for a fund, the fees will be taken out, and the rest of the money will be divided by the cost of the fund’s share value.
For instance, if you invest $10,000 into a mutual fund, with a 5% front-end load fee, you will only be investing $9,500 after the fees are taken out. No-load funds sell shares without the addition of sales charges, though they assess a service fee of .25% or less every time you purchase a share. They are also known as no-front-load-funds, or back-end-load funds. However, the name is deceiving, as they may charge more afterwards by rear-ending you with a fee, than what an upfront fee would have cost. It is always better to know up front what you are going to pay.
4. Long term investors should invest in front-end funds
If you are planning on sticking with a mutual fund longer than 5 years, then invest in a front-end-load fund. The fees will be proportionally less after 5 years and you will see a better rate of return. Short term investors should invest in low front-end load funds or small back end load funds with modest 12b-1 fees. They have the highest annual expenses but are still a better choice than no-front-end load funds. These types of funds should be avoided as they are really expensive with back end load fees, charge the maximum 12b-1 fees and have high annual expenses.
5. Contribute Regularly with Found Money
Add to your holdings regularly, either monthly or quarterly with found money. Found money is extra money that you weren’t expecting, or that you have slowly been putting away, like laundry money. I always put laundry change from my husbands pants in a green vase in the laundry room, then I take it every few months to the coin machine at my bank. The bank machine does not charge me the 8-10% fee that other coin machines charge that can be found at stores. On one trip I had saved up $145. Pretty impressive for change.
Mutual funds are very convenient and easy for starting an investment portfolio and diversifying one. If you need extra help, seek the advice of an financial planner.
