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How To Choose A Mutual Fund As A New Investor

So, you have decided that it is time to get involved with investing, but the landscape looks pretty daunting. After all, there are thousands of mutual funds and seemingly just as many commercials touting the benefits of one fund company or another. But let me propose something a little different than most advice sites do and that is it does not really matter what fund you pick to start off with. Yes, that’s right, pick any old fund for any old reason that strikes your fancy. As long as you are just putting down a small portion of your savings to get the ball rolling it is far, far more important to buy a fund than to get the “right” fund.

I’ll explain further in just a moment, but it is important to note that this post will not be delving into various individual financial situations. This is for those people that have not yet invested in the stock market at all. It will also not deal with bond funds or precious metals funds etc. This is for people that feel that they should have some stocks and, for whatever reasons have not yet pulled the trigger. Also, in many cases a 401k is where one first buys a fund and the choices involved can be quite limited in that area. Still, the following information applies there as well.

The first reason it is important to just buy a fund is that mutual funds are probably the greatest investment invention of all time. For the initial investment of $1,000 (and often much less) you can buy hundreds of stocks all at once. In addition, you do not have to monitor the underlying companies as the money manager does that all for you. You can easily add small amounts of money to that initial investment with nothing more than a phone call to your broker or mutual fund company or simply do it online. In short, mutual funds are almost tailor made for the new investor.

Another reason it doesn’t really matter which fund(s) you start out with is they are all pretty much the same. Now, what I mean by that is that is, yes there are differences in performance among the money managers (although probably less than you think) but it is generally not enough to worry about when you are just starting out. For example, as a new investor it is common (and most of the time, prudent) to pick out a blue chip mutual fund. Blue chip is just the term used to describe the most well known and seasoned companies. These include names like Procter & Gamble, Exxon, Disney, Wal-Mart etc. As a money manager of one of these types of funds, it is very difficult to outperform your peers for any length of time in that all of the other managers own the exact same stocks. This is generally true in even the risky “sector” funds. If a money manager runs a biotechnology fund, well, again there are only so many stocks available to buy, so there will be a large overlap in the portfolios of all similar funds. Now, with riskier sectors such as biotechnology the swings can be enormous, so if one manager makes an unusually high bet on one or two companies and they turn out to be busts, then that fund will woefully under perform its peers. Generally, though, all of the money mangers in a biotechnology fund (or any small sector like that) will all own the same 200 or so stocks in more or less the same proportions. If that particular sector goes on a giant bull run, it is inevitable that your fund will be participating to some degree.

The final, and most important reason is that it will get you in the game. Nothing focuses the mind like participation and even more so when money is involved. This is just human nature and so it may be best to just work with it. Of course, the other side of human nature is what has kept you on the sidelines and that is not wanting to lose money, with a little bit of procrastination and caution thrown into the mix. Once people take the leap and pick out a fund or two, their interest level in investing often takes a leap as well. If you decide to use a broker, you may end up using him as one of your sources for questions. If you have decided to jump in on your own, then quite often, you may find that you are suddenly reading articles that posed no interest to you prior to your purchase. Over time, like anything else, you will slowly learn the ropes and you can get more and more sophisticated. You may even find that the original fund you purchased is just not your cup of tea. That’s fine, as another benefit of mutual funds is that you can switch to another at no cost (within the fund family that you purchased it from).

A couple of notes are in order. Some funds use leverage (this is far more common in ETFs and closed-end funds) and that is probably not what a new investor is looking for. When making a decision on your first fund, it is probably best to choose one with at least a 10 to 20 year track record. They are the least likely to use any little tricks to boost the return. Again, it probably doesn’t matter except in very risky funds, but if you are concerned and can’t figure it out, just ask the fund company (or your broker) if the fund uses leverage. Finally fees are always a big topic. Everywhere you look in the investment world there are warnings not to pay too much in fees. That is certainly something to take into consideration, but the truth is that doesn’t matter either. Sue, if you buy a fund that is more expensive than another one and they both perform exactly the same, then over time the cheaper one will be better. But nowadays almost all funds fall into the reasonable category and those differences in fees don’t really come into play until you are in long term and have lots of money. In the meantime, it is far more important to jump into the game. Good luck! I’m covering retirement planning all month so be sure to check back or let me know any specific topic that you would like to see covered.