Dear Mike: I've been trying to figure out which mutual funds to buy, but there are just too many. Where do I begin?
With thousands of mutual funds on the market, how can you choose the ones that are right for your individual needs? For starters, you need to know the objective of each mutual fund in which you plan to invest.
Let's take a look at the investment objectives of some of the most popular types of mutual funds:
Growth funds: These invest in the stocks of growing companies, with the goal of providing investors with capital appreciation. In plain English, you invest in these funds for the potential to make your money grow.
If you invest in these funds, you will almost certainly experience the "ups and downs" of the market, but if you hold your funds long enough, and they are well managed, you may increase your investment's potential return.
Growth-and-income funds: As its name suggests, these are structured to provide the potential for both growth in value and current income payments, in the form of interest, capital gains and dividends. (Keep in mind that dividends can be increased, decreased or totally eliminated at any time without notice.) Generally speaking, these funds are less risky than growth funds, yet offer lower growth potential. But if you are interested in adding an income stream to your portfolio, these funds may be suitable for your long-term investment goals.
International funds: You can choose from several types of international funds, including:
* Global funds, which invest in both Canadian and international stocks;
* International funds, which invest primarily outside Canada;
* Country-specific funds, which focus on one country or region; and,
* Emerging market funds, which concentrate on small, developing countries.
These funds generally invest for growth, but they involve special types of risk, such as currency fluctuations and the prospect of investments being affected by political or economic turmoil.
Bond funds: When you invest in a bond fund, you are seeking current income, in the form of interest payments, and the chance to help stabilize a portfolio that might be heavily weighted toward stocks.
Although bond funds generally contain less investment risk than stock funds, they carry a different type of risk: purchasing power risk. In other words, the interest payments you receive from your bond funds may not always keep up with inflation. Remember that bond funds are subject to interest rate risk and fund values may decline as interest rates rise.
Money market funds: These invest in short-term debt instruments and are usually managed to maintain a stable net asset value of $10 per share. However, the value of the fund can fluctuate and it's possible to lose money. Many people place money in money market funds if they want to "park" funds for a short time before investing it elsewhere. You might also use a money market fund as an "emergency fund" containing six to 12 months' worth of living expenses.
While these types of mutual funds have some obvious differences, they also share two important traits in common. First, professional money managers choose the investments, which can be a benefit to you. Second, mutual funds, by owning many different types of securities, offer the advantage of diversification.
Diversification, by itself, cannot guarantee a profit or protect against a loss in a declining market, but it has proven over time to be a very prudent approach to investing.
With such a variety of styles to consider - and different types of risks involved - it's a good idea to work closely with your financial adviser to select the mutual funds that are appropriate for your needs.
Mike Watkins, CFP, FMA, FCSI, CSWP, is a financial adviser with Edward Jones and author of the financial planning guide It's Only Money.