First Steps in Mutual Fund Investing

Mutual funds can be a great fit for a first-time investor.
Because they’re managed by a professional, you don’t have to
wrack your brain about what individual stock or bond to buy
or when to buy it or sell it. At the same time, you get a fairly
diversified portfolio in one fell swoop, which involves much
less risk than if you invest in only one stock.

If you’re uncomfortable with the kind of risk that stocks present,
find a good mutual fund for your launch into investing.
Starting out with a
mutual fund doesn’t represent the end of
your quest; it’s the beginning. You can always select a
handful
of decent stocks down the road to add to your portfolio.

With more than 8,000 mutual funds to choose from, the
world may be your oyster, but you eventually have to make
selections that suit you best. In the next three sections, I talk
about three types of mutual funds that can be good first
investments.

You want to see consistent returns over time and relatively
low expenses (ideally 1% or less). If you read the
report carefully, you can also get a
sense of how a manager
approaches his or her investments, and whether the style is
more aggressive than you’re comfortable dealing with.

Also review the fund’s prospectus, which outlines the fund’s
investment objectives and policies, expenses, and risks. Some
better mutual fund companies are starting to graphically
depict the worst quarter and year they’ve experienced, along
with the best, so that you can quickly get an idea of how low
and high the fund may go with your money.

Balanced funds

Although managers of balanced funds invest to earn
respectable returns, they manage first and foremost to avoid
sizeable losses. To do this, many invest in bonds. In some
fund portfolios, bonds account for as much as 30% or more
of the balanced fund’s holdings.

Balanced funds seek income and capital preservation as their
goal, so they offer moderate capital appreciation as compared
to growth funds. Balanced funds don’t take as hard a hit as
more aggressive funds when the market dips.

Large U.S. growth funds

Large U.S. growth fund managers look for large and mid-size
U.S. companies that are fairly stable performers, but have the
potential to continue growing. Changes in society, such as
the aging of the Baby Boom generation, may be one reason
that some companies have good growth potential. For example,
some managers like companies in health care, entertainment,
travel, and financial services because they have the
potential to benefit from the dollars of older, richer Boomers.

A large-company growth index fund

A manager of an index fund invests in companies whose
stocks are listed in an index such as the Standard & Poors
500. The fund tracks the performance of the index. The S&P
has been the index with the best performance in the past
decade. (See Chapter 8 for details on the S&P.) If you want
even more diversification, try a fund that invests, for example,
in the Wilshire 5000, which tracks all of the stocks listed
in the American Stock Exchange, the New York Stock
Exchange, and Nasdaq.

Rather than trying to predict the direction of the market, the
index funds are designed to match the performance of the
index. These funds are considered to be unmanaged because
they invest and hold the same stocks as in the index.
Unfortunately, the fact that index funds match the performance
of the index is the worst part, too, because in a bear market
(when stock prices drop significantly), index funds have
no place else to turn for investments but to the index.
Remember, however, that index funds can offer the investor
long-term, steady growth.

You can pick a small-company mutual fund, a medium-company
mutual fund, a bond mutual fund, and an international
mutual fund as you continue building your portfolio, but it’s
a good idea to start with a fund that invests in large company
stocks. Because, since the late 1920s, these types of stock have
historical average annual returns of more than 11%, this type
of fund can anchor the rest of your portfolio.