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Cents and Sensibility Guy Steele |
Ask the right questions
before jumping into
a mutual fundMORE than 50 million U.S. households own mutual funds, according to the Investment Company Institute. Yet, it's a pretty good bet that many of these people don't seek out some basic information about what they are buying, and this lack of curiosity can cause problems later on.
So, before you invest in any new mutual funds -- or while you're reviewing the funds you already own -- ask the right questions. Here are a few to consider:
» What is the fund's goal or objective? Some people are disappointed with their mutual fund's performance because they had unrealistic expectations when they invested in the fund. When you buy shares in a mutual fund, it's essential that you know the fund's objective. For example, if you are interested in achieving the maximum capital appreciation possible, and you're willing to take on a relatively high degree of investment risk, then you might be interested in an aggressive growth fund in the appropriate amount. However, if you'd like to help to moderate your risk level, but still work toward achieving some growth opportunities -- along with potential dividend payments -- you might want to invest in a growth-and-income fund. Or, if you're concerned about your tax situation, you might want to invest in a mutual fund that invests primarily in tax-free municipal bonds, which may be subject to state, local and/or alternative minimum tax. Every mutual fund has an objective, just make sure each one you invest in matches yours.
» What is the fund's investment strategy? Even within the parameters of a mutual fund's stated objective, a portfolio manager has considerable latitude in choosing the types of securities -- such as stocks or bonds -- that go into the fund. You'll have a much better sense of what your fund looks like -- and how it fits into your overall portfolio -- if you know why the portfolio managers make their buy and sell decisions.
» What is the portfolio management's history? If a fund changes portfolio managers, big changes can result. That's why you'll want to acquaint yourself with the management history behind a fund. When did the fund open? Is the original manager still with the fund? If not, what changes has the successor made? How have these changes affected the fund? If a new manager comes aboard with a different investment philosophy, you may need to reevaluate your reasons for holding the fund.
» What is the fund's long-term performance? When you look at personal finance magazines, you'll see headlines touting "Today's Hottest Mutual Funds." But by the time you get around to investing in these "hot" funds, they may already be cooling off. That's why you shouldn't get carried away over a fund's short-term performance. Instead, go back five or 10 years. How has the fund performed in a variety of economic environments? How has it performed in comparison to funds with similar objectives? A mutual fund is a long-term investment, so you'll want to know its long-term history.
By getting the answers to these questions, you'll learn a lot about what you can expect from your funds. Of course, you still need to remember that no mutual fund is risk-free. Equity funds are subject to market risk, including the potential loss of principal. Even growth-and-income funds, which are designed to pay dividends, may not always do so.
So consult with your investment professional to find the funds that offer the asset mix, return and risk level that meet your individual needs. Make sure to review the prospectus carefully before investing. The more you know before investing, the better off you will be.
See the Columnists section for some past articles.
Guy Steele is a financial planner and head of the Pali Palms office of Edward Jones. Send planning and investing questions to him at 970 N. Kalaheo Ave., Suite C-210, Kailua, Hawaii, 96734, or call 254-0688