One of the leading ice cream makers lists 72 different flavors. When it comes to mutual funds, you are looking at 9,000 different varieties. These can be broken down into four main investment categories, namely, stocks, bonds, money markets and hybrid funds. Within these four groups there is a large swath of choices. They can be narrowed down by industry sectors such as energy, technology, drugs and pharmaceuticals or financials to name a few. They can be large cap, mid cap or small cap. Still another category deals with degree of risk. Here you have larger multi-nationals paying a good dividend to growth funds to speculative types. Within any one of these sub categories you then have a rating system that measures the performance of each fund. For example, all of the funds within the energy category are rated from highest to lowest.
As an investor in mutual funds, you are concerned most of all with your degree of risk. Your age, size of your family, other financial obligations and your own personal feelings about how much risk to take all play a part in your choice of mutual funds. If you are the conservative type, you might choose a fund that holds large multi-national stocks that pay a high dividend and that follow the major averages such as the Dow and the S & P. On the other hand, if you are more concerned with beating the averages, you might try a speculative fund.
Another key factor in your decision about which mutual fund to invest in is your personal philosophy about the markets. For example, if you believe that the market is an efficient barometer of the economy, you might choose an index fund that tracks the major averages. These are often termed “passive funds.” Here also, you are satisfied with the return of the major averages such as the S & P over the long haul. If, on the other hand, you hold that the market is an inefficient amalgam of thousands of companies, some of which will do well and some of which will go bust, you are looking for a fund that buys and sells companies outside the averages. These are referred to as “actively managed investment funds.” You also believe that your fund manager and traders are expert in finding these special opportunities and you are willing to invest in their fund.
Let’s assume that you have chosen an actively managed investment fund. As with all investments, you have pros and cons for this type of investment. Here are some points to consider:
- The philosophy of the fund is a belief that it can beat the major averages by selecting companies that will provide greater profits in a shorter time span.
- If your fund manager and analysts have uncovered an up and coming company they feel will beat the other companies in that sector, they have the freedom to jump on it and ride it for big profits. An index fund cannot do that because they are not allowed by their prospectus to do so.
- An actively managed fund can be more diversified. They can buy stocks in many different sectors. Here again, an index fund is tied to the stocks in the major averages they are tracking. Here too, some of the stocks in a major average may under perform, bringing the total return lower.
- Actively managed funds can sell losing stocks quickly, while index funds can only allocate buys and sell within their universe of index stocks.
- Overall, these funds can manage risk better. Often you find wild, volatile swings in the major averages.
- Since these funds take more risk, there is also the chance for big losses. Mistakes can be made in choosing stocks and when to buy and sell them.
- With greater trading activity, fees charged to the client tend to be higher.
- Greater trading activity may result in higher capital gains taxes.
Whatever fund you choose, be sure to read the prospectus carefully. It gives you the fund’s investment philosophy and the securities in their portfolio.