Which mutual fund should you invest in?
So which mutual fund should you invest in? Investing in mutual fund may seem like a daunting task, especially with the variety of fund types to choose from. The advantages of mutual fund over other investment vehicles are clear. In mutual fund investing, your money is professionally managed and diversified to a wide array of asset classes, industries and more. It is also considered a low-cost way to own shares from the top companies available in the stock market. Lastly, investing in mutual funds enable you to earn better returns than a typical savings account. If you are prolonging your investment because you don’t know which mutual fund to invest in, then this post will guide you. There are ways you can streamline the selection process by asking these three important questions:
How much risk are you willing to take?
How long is your investment horizon? and
What is your investment goal?With the above questions we get three important terms you need to know (and remember) when it comes to investing - risk tolerance, investment horizon and investment goal. Let's differentiate each.
Risk ToleranceAll investments have some kind of risk involved. So, before investing, you must first identify your risk tolerance. Risk tolerance pertains to your ability and willingness to stomach large swings of the market and its effect on the value of your investment. Depending on your age, income and financial goals, you will fall under three categories: Conservative Moderate Aggressive
Investors under the conservative category are willing to accept little to no risk in their investment portfolios and go for mutual funds that are highly liquid and short-term. You lean more on a mutual fund type that offers steady growth with as minimal risk there is as possible.
If you are in the moderate category, your risk tolerance is on a medium level. You are comfortable in accepting a slightly higher degree of risk for a slightly higher return compared to conservative investors.
For aggressive investors, returns and risks go hand in hand. You are open to more risk and unbothered by sudden movements in the performance of the fund involved for your investments to enjoy a maximum potential return in the long-term.How much risk you are willing to take is important when selecting which mutual fund you should invest in. You want to be with a fund that matches your needs as an investor. Remember this: your risk tolerance may vary as you grow older, as your income becomes bigger and as your financial goals differ. Typically, the younger you are, the more risk you are able to take. As you grow older, you have more needs and responsibilities in life which may mean lower risk you can take. Read next: Top 10 Tips to Successful Investing
Investment HorizonInvestment Horizon refers to the length of time you are willing to stay invested. Your time horizon must be addressed so it is easier for you to choose which mutual fund should you invest in. Investment horizons can range from short-term (six months to one year), mid-term (three to five years) and long-term (10 to 15 years or longer). The rule of thumb is that young people have a longer investment horizon. Why? Because they have more years to keep their money invested and take advantage of compound interest. Those with longer time frame for their investments are more comfortable to take risks for better profit. They don’t get easily swayed by market volatility because they know their money is in for the long run. In contrary, investors with short-term horizons avoid risky investments so they will not incur losses even if it means lower returns. To easily specify which investment horizon you are in, ask yourself how long are you prepared to have your money invested? Is it for a year only? How about 5 years? Or 10 years from now?
Investment GoalsMake sure you pick a fund aligned to your goals. You will make better investment decisions if you are investing with a goal in place. Your goals can be a mix of short-term (travel fund, home renovation and/or buying a car) or long-term (retirement and/or pay-off debts). By setting investment goals, investors know which mutual fund is best suited to attain their goals. Your investment goals must be S.M.A.R.T. (Specific, Measurable, Attainable, Relevant and Time-oriented). Broad goals such as to retire or buy a house, will not do. Smart investment goals should answer three specific questions: when you will achieve it, how you will achieve it and why you want to achieve it. Here is an example of a smart investment goal:
My goal is to retire early at age 40, my goal is to save and invest 30% of my salary every month in an equity fund. Why? Because I want to enjoy my retirement years.There are four primary types of mutual funds:
- Money Market Fund - This fund invests purely in short-term market and debt instrument with one year or less maturity period.
- Bond Fund - This fund invests in long-term debt instruments of governments or corporations.
- Balanced Fund - This invests both in shares of stock and debt instruments.
- Stock/Equity Fund - This invests primarily in shares of stock.
- Index Fund - This invests in a passively-managed portfolio that tracks and/or mirror a particular market.