If you have money that you want to invest,
consider mutual funds as an alternative to individual stocks, which tend to be
more volatile than investing in a mutual fund. But, before you simply select a
mutual fund for investment, you need a strategy and a means to allocate your
money. There are three important considerations for your allocation strategy.
Lack of a Strategy
Mutual funds are collections of
investments that are organized together. They collectively invest in a variety
of stocks, bonds and money markets. According to Jack Piazza of Sensible
Investment Strategies, the first error that most people make when investing in
mutual funds is that they literally do not have a strategy. You must always
have an asset allocation strategy that defines your investment objectives, risk
aversion and time limits for each mutual fund investment. These are three
crucial factors for an allocation strategy. If you do not consider these three
factors, then you will invest haphazardly in mutual funds, failing to yield the
monetary benefits that you desire.
Investigate the Fund
To adequately address your investment
objectives and risk aversion, you need to understand the mutual fund itself.
According to the SEC, be wary of the mutual funds fees and expenses. If your
fund has high fees it should be high performing. High-performing funds tend to
have higher risks and may not be a suitable investment for you. Additionally,
knowing how the fund affects your taxes is also an important part of your
allocation strategy. Be sure you understand how a sale of a mutual fund affects
your capital gains. Know the age and size of the fund. Funds that invest in
smaller companies are called small-cap funds, and funds that invest in larger
companies are called large-cap funds. Larger funds tend to be more stable.
Failing to Diversify
Another error in the allocation
strategy is placing large amounts of your investment portfolio in higher-risk
mutual funds. To many investors, the focus is on the higher reward these mutual
funds can yield, but the high reward comes with higher risk. Always diversify
your portfolio with lower-risk, lower-reward funds and medium-risk,
medium-reward funds along with high-risk, high-reward mutual funds. Diversified
funds have a mixture of investments in both high- and low-risk stocks as well
as bonds, which are debt investments with large institutions or corporations.
Bonds function as loans that the institution takes, and it pays you interest on
the loan amount. According to Piazza, investing 5 to 30 percent of your
portfolio in high-risk mutual funds is reasonable.
Duplicate Mutual
Funds
There are a variety of mutual funds in which
you can invest. Be sure to consult your allocation strategy objectives before
investing in a specific mutual fund. If you fail to do so, you may be investing
in mutual funds that are serving identical objectives in your allocation
strategy. For instance, you could have two mutual funds that focus on small
growth over long time periods. According to Piazza, the duplication lessens the
diversification that investing in mutual funds provides.
