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Picking the Right Mutual Funds
From the editors at WIFE |
Your e-mails tell me time and again
that one of the most daunting tasks you face is picking mutual funds and monitoring their
progress. I’m so busy, you say – how can I make this task easier and less
overwhelming?
People often take a hodgepodge approach to their investments – even those who read
the financial magazines and reports and keep up with the latest performance of mutual
funds, and thus consider themselves astute investors. They often invest in the
hottest-performing mutual funds without first reviewing their goals to determine their
time horizon.
Their approach is bass-akward, like driving by looking in your rear-view mirror rather
than ahead. They load up on sectors that have been in favor in the past, but will be old
news in the future. And next year they do the same. In the end, their investment portfolio
looks as though it were put together by the man who jumped on his horse and rode madly off
in all directions.
Asset allocation
Asset allocation – how to divide your money among the different types of funds –
is the most important investment decision you’ll make.
Studies show that 92% of your investment return depends on the way in which you allocate
your money among the different types of funds, and only 8% of your success depends on the
actual funds in which you invest.
In other words, once you decide the percentage of your money that is going to go into each
type of fund, you could use a dartboard to pick the particular funds without affecting
your return much. (I wouldn’t recommend the dartboard approach, though. It’s
smart to be as careful in picking the funds as you are in allocating your assets.)
There are lots of sites on the Internet where you can enter your information and create an
asset allocation that works for you.
One of my favorites, because it is so simple and easy to modify, is the asset allocator at SmartMoney.com. You
enter the holdings you have now, by category, move a few indicators along a graph line to
represent your future (how long until retirement, your economic outlook, etc), and it
shows you the ideal allocation for you and the modifications you should make to your
portfolio.
Picking the right funds
Once you’ve decided on the asset allocation for you, it’s time to pick the funds
themselves. Diversification is important, not only among different mutual fund categories,
such as stock funds, bond funds, and money market funds, but within those categories as
well.
Your mix of mutual funds should include diversifying across types of funds (money market,
equities, and bonds), across time horizons (short-term, intermediate, and long-term bond
funds), across industries (health care, telecommunications, manufacturing, food,
etc.) and across bond quality (government, corporate, municipal, and high-yield.)
You can increase your diversification among industries as well. If you buy a maximum
growth fund that invests heavily in one industry, such as technology, consider investing
in another fund that invests less in technology and more in old economy companies.
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