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Now that we've covered some of the basics of mutual funds, we're going to turn our attention to the topic of researching a mutual fund. The overall objective here is to find the best mutual fund possible. But what exactly does that mean? We need to better understand how buying shares in a mutual fund can help investors to achieve their financial objectives.
Mutual Fund Research and Financial Objectives
It's important to understand your financial objectives before starting your mutual fund research. Many investors completely skip this step, and that is a big mistake. If you don't understand why you're investing in a mutual fund in the first place, then it's impossible to select the best mutual fund.
Understanding the financial objectives you expect to accomplish will help set the overall direction when you research a fund. This point is illustrated by the following two examples.
Financial Objective: Saving for College
Some investors might consider investing in mutual funds as a good way to save for college expenses for their newborn child. In this example, we are thinking about a long-term timeframe, and an investment that maximizes growth in the early years. If that's true, then you should conduct your mutual fund research with this objective and timeframe.
Financial Objective: Retirement Income
Other investors might be considering buying into a mutual fund as part of their retirement income planning strategy. This type of investor might be less interested in the growth of their account and more interested in its short-term, income-producing potential.
The point here is simply this: Before we can start our mutual fund research, we need to have the end in mind. Once we understand why we are investing in a mutual fund, then it's easier to make our purchase decision.
Different Types of Mutual Funds
As we will soon point out below, there are just a few basic categories of mutual funds. From these basic categories, many different types or combinations of funds are possible. Below are simplified definitions, or explanations, for each of those four basic categories of mutual funds:
Growth Mutual Funds
Also referred to as value funds, a growth mutual fund's investment objective will be to maximize the fund's return on investment. Growth funds will take additional risks with the hope to maximize that return. It's a classic example of the balance of risk and reward at play.
Growth mutual funds are a great choice for investors that do not need a steady source of income in the near term.
Income Mutual Funds
Income-producing mutual funds will attempt to maximize the income-producing benefit of the fund, while preserving the investor's capital. Mutual funds can produce income by investing in bonds, or by selecting stocks with high dividend rates.
Income mutual funds are a great choice for investors that are looking for a reliable source of income each month.
Balanced Funds
A balanced mutual fund is a hybrid, or compromise, between growth and income. These funds are sometimes referred to as blend funds. With this type of mutual fund, the investor is assuming slightly more risk in exchange for additional growth potential.
A balanced fund is a good choice for an investor that is looking for growth potential, while still preserving some income-producing capabilities.
Specialty Mutual Funds
Specialty mutual funds are those that invest in a narrow range of companies. The specific range of companies is usually determined either by size, industry, or geography. Examples of specialty mutual funds include:
- Mid Cap, Small Cap, and Large Cap Funds
- Domestic, Foreign, International, Overseas, or Global Funds
- Precious Metals, or Gold Mutual Funds
- Long-Term, Short-Term, Bond Funds
- Municipal Bond Funds
- Communications, Healthcare, Technology Funds
This is but a small sampling of the types of specialty funds that you might encounter as part of your mutual fund research. As you can imagine, companies managing and offering these funds are in the business of attracting money from investors. By creating a wide array of investment options, these mutual fund companies can attract an even wider array of investors.
Next Up: Evaluating Mutual Funds
Up to this point we've discussed the basics of mutual funds, including terminology and risk. In this publication, we discussed some of the fundamentals involved when conducting mutual fund research. With that information as a background, it's time to start talking about evaluating mutual funds.
About the Author - Buying Mutual Funds Part II
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