One of the foundations of managing investment risk is diversification — or as the old saying goes, “Don’t put all your eggs in one basket.” Most of us don’t have enough money to create a sufficiently diversified portfolio of individual stocks and bonds. However, you can gain an instantly diversified securities portfolio with an investment in a single mutual fund. There are thousands of funds to choose from, but not all are appropriate for every investor’s needs. With a little research, you can find ones that match your investment goals.
- Determine your investment objective and temperament. For example, your goal might be capital preservation, income, capital appreciation or aggressive growth. It doesn’t matter what your objective is, as long as you know what it is. The best aggressive growth mutual fund on the market will do you little good if you need a steady stream of tax-free income. Your investment temperament involves your aversion to risk. If you have a high tolerance for risk, you might get better results from a more aggressive fund. If you have a low risk tolerance, even a good mutual fund can be a bad investment if you lie awake at night worrying about it.
- Contact a mutual fund’s investor relations department to request a prospectus and read it carefully. You will find many funds that match your needs. The Securities and Exchange Commission requires fund companies to provide key information such as fees, sales charges, portfolios and past performance — in plain language and in a standard format, making it easier to compare.
- Follow the instructions in each prospectus to buy the mutual funds you have chosen. Some funds are sold only through investment brokerage firms, while others allow you to buy and sell shares directly with the mutual fund. Unlike stock prices, which tend to fluctuate throughout the day, mutual fund shares trade at their net asset value, which is typically figured once per day after the market closes.
- Invest in a variety of mutual fund categories that match your investment goals and risk tolerance to further diversify your holdings. For example, if your investment goal is current income, you might invest in a corporate bond fund, a municipal bond fund and a fund that invests primarily in dividend-paying utility companies. If your goal is capital appreciation, you might spread your investment between small-company funds, medium-size company funds and international funds. Some mutual fund companies offer a family of funds with different objectives and allow you to switch between funds for minimal transaction fees.