Understanding Mutual Fund Basics & Their Place in your Portfolio

Millions of household investors have placed all or part of their accumulated assets into mutual funds. A mutual fund describes a professionally managed pool of assets. This pool of assets is used by the fund manager to purchase specific equities, bonds or cash instruments to achieve a stated investment objective as outlined in the fund’s prospectus. In today’s investment marketplace, there are nearly 20,000 mutual funds. Are these investments outperforming the underlying market indexes? Why are so many investors drawn to this investment type? And, if you are currently invested in funds, how do you evaluate their performance?  RetireLock helps answer these questions.

Why Investors Select Mutual Funds?

An estimated 80 million Americans have some portion of their portfolios invested in mutual funds. Individual investors are attracted to mutual funds for a variety of reasons, including:

  • The perceived opportunity for increased diversification
  • To take advantage of professional money management
  • Daily liquidity
  • Perceived ability to participate in the stock market while limiting some of the downside risk; they feel safer than investing into individual stocks or bonds
  • Tax benefits
  • Customer service and investing convenience

Here is something to keep in mind, of the 20,000+ mutual funds currently available to retail investors, over 80% underperformed against their subsequent index last year (S&P 500, Nasdaq, etc.). Despite this statistic, there is usually a place for mutual funds within an individual investor’s portfolio. But, they must be the right funds for the investor’s given goals, they must consistently outperform the relevant index and they must be found in the right proportion within the overall portfolio to be effective as an investment.

How to Evaluate a Mutual Fund’s Performance

How do you know if the mutual funds currently held within your investment portfolio are the best choices? Unfortunately, many investors look to last year’s performance data as an indicator of financial success. They see a positive gain, hold their position, and give their portfolio little thought until the following year.

Some things to take into consideration when evaluating your fund’s performance include:

  • Performance Against the Benchmark- Your fund should meet or beat the respective benchmark index’s performance for the same measured period. Be sure to review the 1 year, 3 year, 5 year and 10 year performances.
  • Performance within a Peer Group- A mutual fund’s performance should be in alignment with its peer group, with top funds outperforming the majority of their peers. A fund’s peer group refers to funds of similar size, focused on the same investment objective (i.e. large cap, small cap, international, corporate bonds). Be sure to review the fund’s performance in both strong market and declining market conditions.

One tool that can help you develop comparisons is Morningstar, often considered to be a mutual fund’s report card. When investing in mutual funds, be sure to keep your long-term objectives in mind. You should review your portfolio with a qualified financial advisor at least annually, making small adjustments to fund selections and your overall asset allocation.

While mutual funds have a place in an investment portfolio, there are a number of other investment vehicles that should be considered when designing an overall financial plan. Seek the advice of a qualified professional.

About the Author

Jim Richards - Founder of RetireLock

Jim Richards has built his company, and his reputation, by capturing the human side of Financial Services. Taking the client perspective first, he focuses on dispelling the myths often populating the Financial market. His research and reporting advocates for consumer truth and through this Richards has created a loyal, informed readership.

As doubts and uncertainty in the financial sector have risen, Richards saw the need for an unbiased resource that consumers could turn to for support and created RetireLock. An organization that provides more than just peace of mind, RetireLock works both as a consumer advocate and support to Financial Advisors that want to do it right. The name RetireLock has become synonymous with confidence and certainty; leaving consumers more secure with whom they’re entrusting their financial decisions.

Jim Richards is a syndicated columnist and regular contributor to Scottsdale.com.

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