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How To Pick A Quality Mutual Fund

How To Pick A Quality Mutual Fund

Selecting a mutual fund is similar to picking any other investment in that it requires research and a firm understanding of what you are purchasing. Every investment has an associated level of risk and mutual funds are no different. Mutual funds come in a wide variety of types such as index funds and those which invest in specific sectors like technology or biotech. There are a number of different factors to consider when trying to pick a quality mutual fund which the following sections go over in more detail.

Investment Amount

Most mutual funds allow individual investors to purchase shares in a couple of different ways. The first is to making an initial investment of which there is normally a minimum amount such as $1,000 or $2,000. Many small individual investors want to participate in mutual fund ownership but may not have enough savings available to invest. Another option is to allow automatic monthly withdrawals from a checking account of $50 which can be used in lieu of the minimum initial investment.

Investing Time Frame

Like any other time insensitive investment, the longer you own a mutual fund the smoother the price fluctuations become. Mutual funds are more geared towards a buy-and-hold strategy with a focus on long-term ownership. If you only plan on owning shares for 6 to 12 months, there is a high likelihood, as a result of market fluctuations, that your investment may be worth less when you sell. It is recommended to own mutual fund shares for a minimum of 3 years with the ideal ownership window being between 3 and 10 years.

Risk Tolerance

Purchasing shares in a stock mutual fund is no different than purchasing shares directly in an individual company. While there are some inherent benefits which help minimize risk like diversification and dollar cost averaging, mutual fund shares still go up and down in value. As such, it is important to understand your own risk tolerance and invest in a quality mutual fund which conforms to your investment style. If you worry about losing everything, it is best to stick to an index mutual fund. If you don't mind significant fluctuations in price then a tech sector mutual fund may be more appropriate.

Active or Passive

Mutual fund managers, who are responsible for deciding when to buy and sell portfolio assets and for how long to own them, are often characterized as either passive or active. Actively managed mutual funds often have higher management fees then passive mutual funds but that doesn't necessarily mean they perform better. Many investment advisors recommend owning shares in an index mutual funds. Not only do they reflect overall market performance but they are also passively managed resulting in lower fees for investors.

Read the Prospectus

Before investing in any mutual fund, thoroughly read the prospectus to evaluate its overall quality. Not only does it provide insights into historical performance and management style but it is also required by law to fully disclose all associated fees. A common area to compare between mutual funds is so-called maintenance fees or 12b-1 fees. This one fee can vary drastically between mutual funds leading to significant expense or savings. Another area to look out for, although less common nowadays, is "load" or "no-load" mutual fund designations. Almost all popular mutual funds are of the no-load variety which means they do not charge a fee to buy or sell mutual fund shares. Obviously, avoid load mutual funds at all costs.

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