Mutual Fund Investing Strategy
Many people will tell you that Mutual Fund Investing isn't actually a strategy, but I disagree. When you invest in mutual funds, you and many other investors are pooling money together and trusting a professional fund manager to achieve your investment goals. That makes this a unique approach. There is no other strategy that is based on the investing talent of someone other than the investor. The investor's strategy in this case is to get very good at finding great funds run by talented fund managers whose investing goals are in line with their own.
While Mutual Fund Investors don't have to learn how to implement a traditional investing strategy, there is still a lot involved in identifying top funds and fund managers that are strong enough to beat the market. Mutual Fund Investors must learn enough fundamental analysis and technical analysis to be able to minimize fees and expenses, minimize tax liability and compare a fund's performance to its peer group and to a relevant index. Don't worry if you're hoping to avoid fundamental and technical analysis, the small amount that you'll need to learn for this strategy is easy to master and will be as simple as running your fund through a short mutual fund checklist. The rest of the strategy is criteria based. Mutual Fund Investors develop and constantly refine a set of criteria designed to determine the quality of a fund and estimate its future performance.
Creating your selection criteria sounds like it could be complex but Mutual Fund Investors have an advantage. They have easy access to vast amounts of information because every Mutual Fund is required to provide a prospectus. This document contains a wealth of information and all funds are required to provide the same information presented in a similar format. Once a Mutual Fund Investor gets good at reading a prospectus they can really pick apart a fund's quality, strategy, and potential quickly. Successful Mutual Fund Investors combine prospectus information with the mutual fund data mining and screening tools available at investing research sites such as Morningstar.com to come up with a detailed analysis of each fund before they buy.
Investment Selection Methods
Mutual Fund Investors usually start their research by using the mutual fund screening tools at any of the major investment research sites to identify funds that meet their minimum requirements. If a fund doesn't pass every item on this initial checklist, they won't even bother running it through their quality and performance criteria. Some of the more common metrics on a Mutual Fund Checklist are fund strategy, expense ratio, loads, redemption fees, 12b-1 Fees, capital gains distributions and transaction fees. The checklist is designed to validate that the fund's investment goals, expenses, and tax efficiency are in line with the Investor's. Click the following link if you would like to see a sample Mutual Fund Checklist.
Next, Mutual Fund Investors want to see how the fund is performing. They compare the fund's performance to its industry group and to a relevant benchmark (usually an index). They are typically looking for funds that have outperformed both for long periods of time because this gives them some insight into the talent of the fund manager.
After finding funds that pass their mutual fund checklist and that are outperforming their peers and a relevant index, Mutual Fund Investors know that they have compiled a list of funds worth putting through their fund quality and performance criteria. This final set of selection criteria pulls information from the prospectus and from research websites to determine if the fund is the best available in its category, measures how it will impact the portfolio mix, and predicts future performance. If the fund still looks promising after all of these tests, Mutual Fund Investors know that they have a winner that they can buy with confidence.
Capital Gains Distributions are one of the most confusing stumbling blocks for Mutual Fund Investors. Funds are required to distribute at least 90% of their profits (Capital Gains and Dividends) each year. They pass this to investors and then drop the NAV (fund price) to reflect the distribution. You don't lose any money on the transaction but it does create additional tax liability. Mutual Fund Investors try to limit capital gain distribution expenses by avoiding buying a fund right before its distribution date and by holding funds for a long period of time so that they also receive the return and profit rather than just the additional tax liability.
Even though there are a lot of disclosure laws in place to protect you, you will still receive phone calls, emails, and other solicitations containing misleading mutual fund advertisement that can lead beginners astray. Successful Mutual Fund Investors always put every fund through their mutual fund checklist and review the fund's historical performance. If something seems too good to be true, it probably is.
There are numerous fees associated with Mutual Funds. Here's a simple fact that will help you remember which fees to pay and which to try to avoid. Every fee is optional! That's right, the funds decide what fees they're going to try to get away with charging, so can you guess which ones you should pay? None.
Many new Mutual Fund Investors ask, "if I avoid funds with fees am I passing up the best mutual funds?" Definitely not, the majority of funds, especially high quality ones that you would actually want to buy, have learned that charging these fees hurts their business and puts them at a competitive disadvantage. However, now and then you will still run into a fund that tries to sneak them in, most of these loaded funds and fee-laden funds are sold through financial planners. They will not warn you up front about loads, 12b-1 fees, redemption fees and other transaction charges because that's how they make a living. Smart Mutual Fund Investors always verify that there are no fees before they buy.
Minimum investments are more of an annoyance to Mutual Fund Investors that don't yet have a lot of capital. It's very frustrating to do all your homework and decide that you want to buy a fund only to find out that you don't have the $5,000 minimum investment. Take heart, if you invest wisely your money will grow quickly and soon you won't even bat an eye at minimum amounts.
Mutual Funds have two advantages over stocks when it comes to size. A stock that performs well for several years in a row will inevitably get to a point where it is nearly impossible to top last year's performance or meet analyst projections. Conversely, the longer a fund manager runs a fund, the more savvy and experienced he becomes so in most cases performance constantly improves. In addition, as a fund grows your returns actually improve because the management fees become a smaller percentage of total assets (economies of scale). Admittedly, it can be tough to manage the mega funds that get up into the billions but every fund manager has the option to close the fund to new investment if they feel that performance is deteriorating.
Mutual Funds are becoming the investment of choice for online investors because you can trade them for free through the major online brokerages, there are no fees or loads. Transaction fees add up quickly for most strategies, free trading is a significant perk for Mutual Fund Investors, especially those investors that trade a lot. Mutual Fund Investors also try to avoid funds with high expense ratios or they will have squandered this advantage. A good rule of thumb is to avoid fees with expense ratios > 1.5% unless you expect extraordinary returns.
Diversification is one of the greatest strengths of mutual funds. Each fund represents an entire portfolio, not just one stock. Because a fund owns an entire portfolio of stocks, you have a lot of protection from losses. In addition, a fund's portfolio is managed by a professional fund manager whose career and income is directly tied to how well he chooses investments for you, the person paying his salary (no investors = no fund).
The amount of information that funds are required to disclose makes their strategy and performance almost transparent. We wish this were true for individual companies, but the recent 2007-2008 subprime mortgage crisis proves this isn't the case since financial institutions keep surprising the market with multibillion dollar loss announcements. It's very difficult for a mutual fund to fool wary investors, problems are pretty obvious to anyone that knows what to look for. To protect themselves, Mutual Fund Investors periodically run each fund back through their checklists to make sure that expenses, strategy, and performance are still in line with expectations.
Mutual Fund Investing is a very popular strategy that is already huge and will continue to grow. It is the only strategy that will allow you to test drive any of the other strategies without actually having to master them yourself. Today, there are over 10,000 funds to choose from and they cover every industry and investing strategy imaginable.
This is one of the few strategies that will serve you well for a lifetime. Not only is it a low maintenance strategy since fund managers are the ones actually managing your money but it also offers Mutual Fund Investors enormous flexibility. For example, as you approach retirement, you can shift to a more conservative strategy. For example, you can shift from growth stocks into income producing Blue Chips and Bonds by simply buying funds aligned with your new investing goals.
This strategy is a proven long-term market beater, but you will have to master selecting top notch fund managers since only about 20% of all funds beat the market. Should that discourage you? No, certainly not, it should only make you realize that you can't trust just any "professional" with your money, you have to learn how to identify the most talented. Many of the best Mutual Fund Investors, such as Thurman Smith, have beaten the market significantly for over 20 years and counting. Successful Mutual Fund investors never stop refining their Mutual Fund selection criteria.
There are several types of investors that naturally gravitate towards Mutual Fund Investing. This is a great strategy for anyone that likes to change strategies frequently or wants to test a new strategy out before they spend an enormous amount of time and energy trying to master it. Another investor type that is a good fit is anyone that doesn't want to spend a lot of time managing their portfolio. These investors would rather spend a little time identifying strong funds with talented fund managers and then let a professional manage their money. This is also a popular strategy for anyone trying to minimize transaction costs, most mutual funds trade free of charge through online investing brokerages.
This strategy isn't a good fit for everyone, some investing goals and investing styles clash badly. For example, Aggressive Growth Investors that are looking to hit Google-like home runs are not a good fit. Why? Mutual funds own an entire portfolio, not just one stock. This diversification decreases the risk of losses but it also means that if a fund owns a company like Google its returns will be averaged with the rest of the portfolio.
For those that are not net-savvy and have no desire to learn how to use online investing research tools, this is going to be a tough strategy. The information provided by sites like Morningstar.com is critical to a Mutual Fund Investor, it saves them an enormous amount of time, work and money. A prospectus contains a lot of information but can't, by itself, tell you enough about a fund to make a purchase decision even if you read it cover to cover.