How to Pick a Mutual Fund - dummies

How to Pick a Mutual Fund

By Stephen L. Nelson

Here are a handful of tips about how to pick a mutual fund from a former registered investment adviser and current CPA who has seen countless real-life examples of people’s investing successes and mistakes. Maybe, just maybe, these observations might be useful to you.

  1. Carefully watch your investment expenses, including both commissions and the mutual fund management fees.

    Why? Despite what you may have been told, you almost never get extra investment returns by paying extra for investment advice or financial planning. And note that every bit of financial research — the kind that finance professors do — supports this statement.

    Usually, you want to pick the cheapest mutual fund alternative. Almost always, that’s an index fund. And one other note: Remember that paying a 2 percent fee on investments earning 8 percent means you’re giving up 25 percent of your profit to the mutual fund or financial advisor. That’s like a 25 percent tax!

  2. Use tax-deferred investment accounts like 401(k)s, 403(b)s, and IRAs for your investments.

    Income taxes can be a huge drag on your investment returns. And over the decades that you’ll be investing, minimizing your income taxes will add at least tens of thousands of dollars and potentially hundreds of thousands of dollars to your wealth.

  3. To diversify, use an inexpensive index fund, one per investment category.

    For example, you can diversify by investing in one index fund that invests in the U.S. stock market, another index fund that invests in corporate bonds, another that invests in real estate investment trusts, and so on. Diversification reduces your investment risk.

  4. Consider one of the new target retirement funds such as those offered by Vanguard, T. Rowe Price, or Fidelity.

    With one of these babies, you don’t worry about trying to diversify. You don’t worry about asset allocation or rebalancing. You don’t worry about adjusting your investment mix as you get older.

    You just pick a single fund that’s tied to your retirement year. For example, if you will retire in 2025, you would buy the target retirement that assumes you’ll retire in 2025. That’s it. That’s the last investment decision you need to make.

  5. For goodness’ sake, don’t trade, attempting to buy low and sell high. Trading rarely works.

    And it’s always expensive. Be a long-term investor who buys inexpensive mutual funds and holds them for the long term.

  6. Invest some time and money in beefing up your investment knowledge.