Your Instant Portfolio
By: Karen Hube Source: AARP The Magazine Date Posted:
What's the biggest challenge to mutual fund investing? Ask anyone who has ever done it and you'll probably get the same answer: getting started.
With more than 17,000 mutual funds to choose from, taking the first step is a little like walking into a shopping mall on the day after Christmas. You know there are some good deals there, but how do you begin to find them?
"It's even more overwhelming for people near the end of their careers because they have to balance the need to grow their assets quickly with the need to safeguard what they have," says Mark Salzinger, publisher of The No-Load Fund Investor, a monthly newsletter. "Unlike younger people, they may not have enough time to make up for any big losses."
Thankfully, however, building a sound mutual fund portfolio doesn't require a membership in Mensa. Nor does it take months of scrutinizing annual reports. It does require knowing what information you need and where to find it. And that's what we're going to tell you. Start by reading through the six steps you should take to become a successful mutual fund investor. Then browse through our three mutual fund-investing strategies and choose the one that makes the most sense for you. (The first two are designed especially for the investor who doesn't want to do any heavy lifting.) All three strategies offer a significant payoff: if you invest just $20 a day in a portfolio earning an average annual 8 percent, you'll have almost $300,000 after 18 years. "You have the power to change your retirement simply by getting started now," says Lynn Ballou, a financial adviser in Lafayette, California. So grab a pencil and paper and a cup of coffee and let's begin.
Learn how mutual funds work
You'll need: A primer on mutual funds
How long it'll take: An evening at home
Whenever you tackle a challenge for the first time, it helps to get a quickie course on the basics. Here's the one-minute version: mutual funds pool money from thousands of investors to buy a portfolio of stocks, bonds, and other investments. Some funds have a focused portfolio—for instance, they might contain only technology stocks. Others are widely diversified over a range of different types of stocks and bonds.
The nifty thing about mutual funds is they give investors access to a broad portfolio without the investor's having to buy dozens of individual stocks and bonds. To achieve such diversification without mutual funds, you would need more than $100,000—and have to spend a lot of time researching the markets.
The mutual funds of which we speak—all 17,567 of them—are offered by 567 different mutual fund companies, with names like Vanguard, Fidelity, T. Rowe Price, American, Oppenheimer, and PIMCO. (We'll give you tips on how to sort through the various funds, below.)
To invest, you can call a fund company directly or work with a financial adviser to pick a few that meet your investment goals. Once you're in, you'll receive monthly or quarterly statements detailing how your fund has performed.
That's a quick overview, and it's probably all you really need to know. But if you want to delve deeper, go to the library and check out a book (or two). Two good ones are The New Money Book of Personal Finance (Warner Business Books, 2002) and The Wall Street Journal Guide to Understanding Money and Investing (Fireside, 2004).
Strike the right balance
You'll need: An honest gut check and a calculator
How long it'll take: An hour
Before you select funds, you need to know what you're trying to achieve. How much do you want to hold in stocks? in bonds? in cash? The answer depends on how many years you have to invest before you need to draw income from your investments, and how comfortable you are with temporary dips in your portfolio's value. The less time you have to invest, the smaller your stock allocation should be, because you'll have less time to make up for downswings in the market. As a general rule of thumb, if you're ten years or more away from retirement, you should hold the majority of your portfolio in stocks—from 60 percent at a bare minimum to 90 percent, depending on your comfort level.
If the idea of playing the market makes you feel a little woozy, you are probably just anticipating the roller coaster ride that investing in stocks can be. "But in the long run, stocks will give you the biggest returns, so you can't afford to be too conservative," says Ballou. According to Ibbotson Associates, a market tracker in Chicago, stocks have returned an average annual 10.4 percent since 1926, while bonds have returned an average 5.5 percent.
So why even bother with bonds? Also known as fixed-income investments, bonds behave differently from stocks, so they help to steady a portfolio's returns. When stocks go down, bonds generally go up, and vice versa. So your bonds should help balance out your portfolio.
Spread your bets around
You'll need: Access to the Internet
How long it'll take: An afternoon
You may be tempted to sink most of your money into a single fund that invests in a promising area of the market—say, Japanese stocks, which some forecasters think will have a good year in 2006. Indeed, if the outlook is good, why not? Here's why: because when that segment of the market hits hard times, your portfolio will, too.
Instead, if you spread your money across a number of different kinds of stocks and bonds, you'll reduce your portfolio's volatility. Your stocks should include a mix of large and small companies in different sectors, growth and value holdings, and some international exposure. And in your bond bucket you should hold some Treasury and corporate bonds with varying maturities.
Mutual funds make diversification easy. You can invest in a few funds that divide your portfolio between stocks and bonds and that give you a mix of investments in each asset class. To learn more about various sectors of the market, go to www.bloomberg.com and click on Market Data.
Size up some funds
You'll need: Access to the Internet
How long it'll take: A few weekend afternoons
Okay, now it's time to look at some individual mutual funds. This is where the panic usually sets in—with 17,000-plus mutual funds to choose from, where do you begin?
One place is with the Fund Screener at www.morningstar.com, run by the Chicago-based mutual fund tracker Morningstar Inc. Here's how it works: say you want to find a diversified U.S. stock fund. Using the tool's easy-to-follow prompts, you click on domestic stocks and then on your screening thresholds. You might want a no-load fund with a minimum expense ratio of less than or equal to the fund category's average (see step 5 for more on how to evaluate costs), a turnover rate (the rate at which funds buy and sell assets) of less than 25 percent, and a Morningstar rating of four or five stars (five is the maximum). After plugging in that information, you will have pared your list to about 130 funds. The site will then give you the list of 130 or so funds, their year-to-date returns, expense ratios (including the average for the category, which is 1.42 percent), and assets under management. From there you can screen further—if you want funds that will accept an initial investment of $500 or less, that narrows the list to 22. And if you want funds that charge well below the average 1.42 percent—0.5 percent or less—that whittles the list to 8.
Now it's time to look at finer details. Click on any of the funds to get its performance data, as well as information on how the fund invests and its management.
In particular, take a close look at who is running the fund. Does the manager have a long track record? a clear strategy for picking stocks? steady year-by-year returns? "It's all about the manager," says Stewart Welch III, a financial planner in Birmingham, Alabama. "If a fund has been doing great and the manager leaves after a long tenure—forget about it. A smarter choice might be the fund the manager goes to next."
If you can't glean information about the manager from Morningstar's website, call the company (or go to the company's website) to get the manager's history, or check out the investing resource The Value Line Investment Survey at your local library.
Keep costs down
You'll need: Access to the Internet
How long it'll take: An afternoon
Like any other business providing a service, a mutual fund company will charge you to invest your money. Your job is to make sure you're not paying too much. "The nearer people are to retirement, the more vigilant they should be about keeping costs down," says Christine Benz, associate director of fund analysis at Morningstar. "If you expect an 8 percent return, can you really afford to give up 1.25 percent in expenses?"
So now take a closer look at the group of "finalist funds" you identified using Morningstar's Fund Screener in step 4. Do any of them have letters after their names? If they do, they likely will charge a fee either to get into the fund or out of it. In general, funds with an A after their names charge a front-end load (or fee to get into the fund), while funds with a B after their names charge back-end loads (or fees to get out of the fund). "Stick with funds with no letters after their names," Salzinger says.
You'll also want to examine a fund's expense ratio, which includes its operational and management fees. These expenses vary, depending on the kind of fund you're looking at. For example, the average expense you pay on a domestic stock mutual fund is 1.42 percent; on a corporate bond mutual fund, 1.09 percent. "Make sure a fund's expenses are reasonable compared with those of its peers," says Ballou.
Costs are also incurred by funds in the form of taxes. As a fund buys and sells investments, it triggers capital gains that are paid out to investors, who must report these on their tax returns. While all funds buy and sell investments, their "turnover' rates—the pace at which they buy and sell securities—can be vastly different.
You can find information on loads, expenses, and turnover rates at www.morningstar.com. Type the fund's name into the site's search engine to get a comprehensive report that lists these details. If you're not sure of a fund's name, the site lists all the funds offered by each fund family, so you can scan those. If you prefer paper reports, look for Morningstar mutual funds reports at your library's reference desk.
Hang in there
You'll need: Patience
How long it'll take: The rest of your life
It's bound to happen: once you've selected your mutual fund portfolio, you'll hear about a hot fund that has blown away its competitors. Or you'll see a market forecaster on CNBC predicting that emerging markets will be the next hot place to stash your cash. The temptation to sell one of your funds and follow the buzz may be overwhelming—but whatever you do, don't budge. At least not in the short term.
Almost without fail, investors who actively move money between investments lose, says David Bugen, a financial planner in Chatham, New Jersey. They end up making all the wrong moves, such as selling shares when prices are low and buying when prices are high.
According to a 2004 study by Dalbar, a Boston-based mutual fund research firm, investors in stock mutual funds who bounced in and out of their funds to try to time the market over the previous 20-year period paid dearly. Their average annual return: they lost 3.29 percent, compared with the S&P 500's 12.98 percent gain.
The best way to earn steady returns is to stay in the market and invest systematically. Here's how: once you've chosen a fund, call its toll-free number to sign up for its automatic-investment program, which will deduct a certain amount from your bank account each month or quarter and invest it. The big advantage to automatic investments is that because you're investing the same amount each month, you're buying less when prices are high and more when prices are low.
Now that you've learned all about mutual funds, it's time to build your portfolio. Read through our three mutual fund investing strategies. And remember, the earlier you start, the closer you'll be to financial freedom in retirement.
Karen Hube is a financial writer in Westport, Connecticut. For black-and-white reprints of this article, call 866-888-3723.
With more than 17,000 mutual funds to choose from, taking the first step is a little like walking into a shopping mall on the day after Christmas. You know there are some good deals there, but how do you begin to find them?
"It's even more overwhelming for people near the end of their careers because they have to balance the need to grow their assets quickly with the need to safeguard what they have," says Mark Salzinger, publisher of The No-Load Fund Investor, a monthly newsletter. "Unlike younger people, they may not have enough time to make up for any big losses."
Thankfully, however, building a sound mutual fund portfolio doesn't require a membership in Mensa. Nor does it take months of scrutinizing annual reports. It does require knowing what information you need and where to find it. And that's what we're going to tell you. Start by reading through the six steps you should take to become a successful mutual fund investor. Then browse through our three mutual fund-investing strategies and choose the one that makes the most sense for you. (The first two are designed especially for the investor who doesn't want to do any heavy lifting.) All three strategies offer a significant payoff: if you invest just $20 a day in a portfolio earning an average annual 8 percent, you'll have almost $300,000 after 18 years. "You have the power to change your retirement simply by getting started now," says Lynn Ballou, a financial adviser in Lafayette, California. So grab a pencil and paper and a cup of coffee and let's begin.
Learn how mutual funds work
You'll need: A primer on mutual funds
How long it'll take: An evening at home
Whenever you tackle a challenge for the first time, it helps to get a quickie course on the basics. Here's the one-minute version: mutual funds pool money from thousands of investors to buy a portfolio of stocks, bonds, and other investments. Some funds have a focused portfolio—for instance, they might contain only technology stocks. Others are widely diversified over a range of different types of stocks and bonds.
The nifty thing about mutual funds is they give investors access to a broad portfolio without the investor's having to buy dozens of individual stocks and bonds. To achieve such diversification without mutual funds, you would need more than $100,000—and have to spend a lot of time researching the markets.
The mutual funds of which we speak—all 17,567 of them—are offered by 567 different mutual fund companies, with names like Vanguard, Fidelity, T. Rowe Price, American, Oppenheimer, and PIMCO. (We'll give you tips on how to sort through the various funds, below.)
To invest, you can call a fund company directly or work with a financial adviser to pick a few that meet your investment goals. Once you're in, you'll receive monthly or quarterly statements detailing how your fund has performed.
That's a quick overview, and it's probably all you really need to know. But if you want to delve deeper, go to the library and check out a book (or two). Two good ones are The New Money Book of Personal Finance (Warner Business Books, 2002) and The Wall Street Journal Guide to Understanding Money and Investing (Fireside, 2004).
Strike the right balance
You'll need: An honest gut check and a calculator
How long it'll take: An hour
Before you select funds, you need to know what you're trying to achieve. How much do you want to hold in stocks? in bonds? in cash? The answer depends on how many years you have to invest before you need to draw income from your investments, and how comfortable you are with temporary dips in your portfolio's value. The less time you have to invest, the smaller your stock allocation should be, because you'll have less time to make up for downswings in the market. As a general rule of thumb, if you're ten years or more away from retirement, you should hold the majority of your portfolio in stocks—from 60 percent at a bare minimum to 90 percent, depending on your comfort level.
If the idea of playing the market makes you feel a little woozy, you are probably just anticipating the roller coaster ride that investing in stocks can be. "But in the long run, stocks will give you the biggest returns, so you can't afford to be too conservative," says Ballou. According to Ibbotson Associates, a market tracker in Chicago, stocks have returned an average annual 10.4 percent since 1926, while bonds have returned an average 5.5 percent.
So why even bother with bonds? Also known as fixed-income investments, bonds behave differently from stocks, so they help to steady a portfolio's returns. When stocks go down, bonds generally go up, and vice versa. So your bonds should help balance out your portfolio.
Spread your bets around
You'll need: Access to the Internet
How long it'll take: An afternoon
You may be tempted to sink most of your money into a single fund that invests in a promising area of the market—say, Japanese stocks, which some forecasters think will have a good year in 2006. Indeed, if the outlook is good, why not? Here's why: because when that segment of the market hits hard times, your portfolio will, too.
Instead, if you spread your money across a number of different kinds of stocks and bonds, you'll reduce your portfolio's volatility. Your stocks should include a mix of large and small companies in different sectors, growth and value holdings, and some international exposure. And in your bond bucket you should hold some Treasury and corporate bonds with varying maturities.
Mutual funds make diversification easy. You can invest in a few funds that divide your portfolio between stocks and bonds and that give you a mix of investments in each asset class. To learn more about various sectors of the market, go to www.bloomberg.com and click on Market Data.
Size up some funds
You'll need: Access to the Internet
How long it'll take: A few weekend afternoons
Okay, now it's time to look at some individual mutual funds. This is where the panic usually sets in—with 17,000-plus mutual funds to choose from, where do you begin?
One place is with the Fund Screener at www.morningstar.com, run by the Chicago-based mutual fund tracker Morningstar Inc. Here's how it works: say you want to find a diversified U.S. stock fund. Using the tool's easy-to-follow prompts, you click on domestic stocks and then on your screening thresholds. You might want a no-load fund with a minimum expense ratio of less than or equal to the fund category's average (see step 5 for more on how to evaluate costs), a turnover rate (the rate at which funds buy and sell assets) of less than 25 percent, and a Morningstar rating of four or five stars (five is the maximum). After plugging in that information, you will have pared your list to about 130 funds. The site will then give you the list of 130 or so funds, their year-to-date returns, expense ratios (including the average for the category, which is 1.42 percent), and assets under management. From there you can screen further—if you want funds that will accept an initial investment of $500 or less, that narrows the list to 22. And if you want funds that charge well below the average 1.42 percent—0.5 percent or less—that whittles the list to 8.
Now it's time to look at finer details. Click on any of the funds to get its performance data, as well as information on how the fund invests and its management.
In particular, take a close look at who is running the fund. Does the manager have a long track record? a clear strategy for picking stocks? steady year-by-year returns? "It's all about the manager," says Stewart Welch III, a financial planner in Birmingham, Alabama. "If a fund has been doing great and the manager leaves after a long tenure—forget about it. A smarter choice might be the fund the manager goes to next."
If you can't glean information about the manager from Morningstar's website, call the company (or go to the company's website) to get the manager's history, or check out the investing resource The Value Line Investment Survey at your local library.
Keep costs down
You'll need: Access to the Internet
How long it'll take: An afternoon
Like any other business providing a service, a mutual fund company will charge you to invest your money. Your job is to make sure you're not paying too much. "The nearer people are to retirement, the more vigilant they should be about keeping costs down," says Christine Benz, associate director of fund analysis at Morningstar. "If you expect an 8 percent return, can you really afford to give up 1.25 percent in expenses?"
So now take a closer look at the group of "finalist funds" you identified using Morningstar's Fund Screener in step 4. Do any of them have letters after their names? If they do, they likely will charge a fee either to get into the fund or out of it. In general, funds with an A after their names charge a front-end load (or fee to get into the fund), while funds with a B after their names charge back-end loads (or fees to get out of the fund). "Stick with funds with no letters after their names," Salzinger says.
You'll also want to examine a fund's expense ratio, which includes its operational and management fees. These expenses vary, depending on the kind of fund you're looking at. For example, the average expense you pay on a domestic stock mutual fund is 1.42 percent; on a corporate bond mutual fund, 1.09 percent. "Make sure a fund's expenses are reasonable compared with those of its peers," says Ballou.
Costs are also incurred by funds in the form of taxes. As a fund buys and sells investments, it triggers capital gains that are paid out to investors, who must report these on their tax returns. While all funds buy and sell investments, their "turnover' rates—the pace at which they buy and sell securities—can be vastly different.
You can find information on loads, expenses, and turnover rates at www.morningstar.com. Type the fund's name into the site's search engine to get a comprehensive report that lists these details. If you're not sure of a fund's name, the site lists all the funds offered by each fund family, so you can scan those. If you prefer paper reports, look for Morningstar mutual funds reports at your library's reference desk.
Hang in there
You'll need: Patience
How long it'll take: The rest of your life
It's bound to happen: once you've selected your mutual fund portfolio, you'll hear about a hot fund that has blown away its competitors. Or you'll see a market forecaster on CNBC predicting that emerging markets will be the next hot place to stash your cash. The temptation to sell one of your funds and follow the buzz may be overwhelming—but whatever you do, don't budge. At least not in the short term.
Almost without fail, investors who actively move money between investments lose, says David Bugen, a financial planner in Chatham, New Jersey. They end up making all the wrong moves, such as selling shares when prices are low and buying when prices are high.
According to a 2004 study by Dalbar, a Boston-based mutual fund research firm, investors in stock mutual funds who bounced in and out of their funds to try to time the market over the previous 20-year period paid dearly. Their average annual return: they lost 3.29 percent, compared with the S&P 500's 12.98 percent gain.
The best way to earn steady returns is to stay in the market and invest systematically. Here's how: once you've chosen a fund, call its toll-free number to sign up for its automatic-investment program, which will deduct a certain amount from your bank account each month or quarter and invest it. The big advantage to automatic investments is that because you're investing the same amount each month, you're buying less when prices are high and more when prices are low.
Now that you've learned all about mutual funds, it's time to build your portfolio. Read through our three mutual fund investing strategies. And remember, the earlier you start, the closer you'll be to financial freedom in retirement.
Karen Hube is a financial writer in Westport, Connecticut. For black-and-white reprints of this article, call 866-888-3723.
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