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 Now that you understand some of the basics of mutual funds, we're going to start discussing how to research a mutual fund. You're overall objective here is to find the best mutual fund possible, but what exactly does that mean? For example, what are the financial objectives that buying a mutual fund can help me accomplish?
Financial Objectives and Mutual Fund Research
You need to understand the answer to these questions before you can start researching mutual funds. 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 how can you possibly select the best mutual fund?
Understanding the financial objectives you expect to accomplish by putting your hard earned money in a mutual fund will help set the overall direction when you research a fund. We can illustrate this point with a couple of examples.
Financial Objective - Saving for College
Some investors might be considering investing in mutual funds as a 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 investing in 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. We need to understand why we are investing in a mutual fund in the first place and that should drive our research and ultimately our investment decisions.
Different Types of Mutual Funds
Once that we have a good understanding of the investment objective we expect to fulfill, we can start researching a list of potential mutual funds. This way we can select the best mutual fund from a list of fund that will help us meet our objectives.
As we will point out below, there are just a few major categories of mutual funds and many more different types of funds that are spawned from those major categories. Below are some simplified definitions / explanations for each of those categories:
Growth Mutual Funds
Also referred to as value funds, a growth mutual fund's investment objective will be to attempt to maximize the fund's return on investment. Growth funds will take additional risks to maximize that return. It's the old balance of risk and reward at play.
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.
Balanced Funds
A balanced mutual fund is a hybrid, or compromise, between growth and income. These are sometimes referred to as blend funds. With this type of mutual fund, the investor is assuming a bit more risk in exchange for additional growth potential.
Specialty Mutual Funds
Specialty mutual funds are those that invest in a narrow range of companies. The range of companies is usually determined either by size, industry, or geography. Examples of specialty mutual funds include:
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Foreign, Overseas, or Global Funds
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Municipal Bond Funds
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Communications, Health Care, Electronics Funds
This is but a small sampling of the types of specialty funds that you might encounter in the marketplace while researching mutual funds. 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
So far in this series we've discussed the basics of mutual funds including terminology, risk. In this article we discussed some of the fundamentals involved 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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