Before you jump into more mutual funds, here are some things you should know for 2010.
If history is a guide, then 2010 will be a better year for mutual funds. When the economy goes through a deep slide, it is often followed by an impressive upturn. No one knows for sure what will happen, but consumers are spending more money, the stock market is rising, and optimism is beginning to surface. Treasury Secretary Timothy Geithner says that the economy is healing and growing.
Will mutual funds be a safe place to invest in 2010? Mutual funds are baskets of stocks (equities) or bonds or a combination, in which investors can buy shares. The shares are traded at Net Asset Value (NAV) and fluctuate, depending on the financial markets. Mutual funds are a popular investment vehicle because they offer an opportunity to own a variety of different stocks and bonds. But not all funds are created equal and historical returns do not guarantee future performance.
To determine the safety of mutual funds going forward, there are several issues that any investor should consider.
First, what is your time horizon or length of time you plan to hold the funds? Are you investing for one year, five years, or long term? If the value of a fund falls, do you have time to let it catch up?
Investing and timing go hand in hand. Nobody knows for sure if the value of a fund will go straight up or rise steadily. For example, EWZ, the Brazil exchange traded fund, had an NAV in the $30 range in July 2006. By January 2008, the NAV had risen to the $80 range, before plummeting back to the $30 range in December 2008, when the recession took hold. As of December 3, 2009, EWZ was again trading in the $78-$80 range. It’s had a see-saw ride.
Second, what is your risk tolerance? The greater the risk, the greater the reward, is how it theoretically works, but not always. If you want to minimize risk, invest in a short-term government bond fund. If you can tolerate more risk, for potential higher rewards, a commodities or equities fund might be the choice. These are only examples.
Third, investing in mutual funds is a good idea, but which one? There are thousands of mutual funds, including asset allocation, sector funds, such as industrials, materials, and consumer discretionary, technology, energy and so on down the line. Then there are many types of mutual funds that are comprised of bonds, including corporate, government, TIP, or municipal bonds.
The decline of the U.S. dollar argues for keeping a portion of your stock portfolio in foreign shares. Look for funds that invest in foreign companies where there is fast growth, such as China and Latin America.
Wow! The original question about the safety of mutual funds is not that easy to answer. You can begin to see that uncertainty lies everywhere. But still, if you do have extra cash, it is better to invest it in a promising mutual fund with a solid track record than spending money at the department store buying extra clothes to hang in your closet.
To get down to the bottom line, next year looks like it will indeed be a good year to invest in the financial markets. The difficult part is identifying the mutual funds you think look safe. There are a number of places you can check to do research.
It’s not a bad idea to read magazines that provide investing ideas. To name a few, there is Money, Smart Money, and Kiplinger’s. Read the Wall Street Journal every day. You can also check lots of websites, such as SeekingAlpha.com, and especially, Morningstar.com, which rates mutual funds.
Here are several general rules to follow:
Check out the fund’s track record and the manager’s history with the fund. Know what you own in your funds to avoid overlapping. For example, if you choose a Consumer Discretionary sector fund, the top holdings might be McDonald’s Corp. (MCD), Walt Disney (DIS) and Home Depot (HD). But you might already have a Large Cap fund with the same stocks. Seek funds that fill holes in your portfolio. Choose funds that are tax efficient. Find out the turnover rate of the fund. Some fund managers do too much trading and create capital gains that may hurt you when it comes time to pay taxes, unless you are holding the fund in an IRA or other type of retirement fund. Do your homework. Identify top fund managers and funds where the majority of years they came out on the plus side. Look up funds on Fidelity Investments website or on Morningstar.
Here is one more piece of advice. In a flourishing economy, people feel richer and start to spend too much money on frivolous things. Trick yourself by putting away money automatically. One place to start is a mutual fund with a solid track record and a fund manager who has extensive experience in stock picking and managing a fund.