Mutual Funds Boring You?
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Fund wealth is a long term horizon. The value of money invested in a mutual fund will increase over time. Makes sense to me. Individual stocks will go up and down over the short term. We can thank volatility and investor psychology for that. But funds are a conglomeration of individual business. As dividends and earnings rise, so will the fund’s price per share, over the long run.
An investment manager has put together a portfolio of companies that he or she and their computers feel are good stocks. Although price appreciation may not happen within the next month, it is likely it will. Over time. Stand by that 'ol mutual fund. It will make you miney.
There is a plethora of mutual funds to choose from. We have industry specific, contrarian, special situation, small-cap, large-cap, the list goes on. I simply recommend an index fund. What? An S&P 500 index fund? What about a fund that focuses on energy companies? Look at the price of oil! Do I want to miss out on that appreciation?
The mutual fund industry has become marketers of consumer products. Are energy or cell phone companies the next best thing? Well, here’s a mutual fund that specializes only in those companies. Like to go bottom fishing for stocks? Here’s a fund that does just that.
Funds that specialize in a certain type of strategy have high costs. You know those ads with that lion staring at you. Or the one with the confident looking guy in a Brooks Brothers suit saying, "Don't worry, your money is safe with me. Just look at how I'm dressed." Well, you're paying for those ads.
The fund’s management also gets a higher fee. They do have to work harder to find those companies. Fund costs are one of the most important factors that determine your return. Because, these fees are paid by you. If your fund has high expenses, over the long term, your returns are lower.
Many specialized funds have expenses which aren't readily apparent. These fees in addition to taxes on stock market gains, all take their toll on your return. Index funds are a way to minimize these fees.
A fund pegged to the Standard & Poor’s 500 Index is a perfect place to invest in. Here’s why. It is comprised of America’s 500 largest corporations. Not some random list generated by a dart throwing monkey.
Mid to large size companies got that way because they’re growing. And if their luck continues, they'll keep growing. That’s the type of company that makes you money in the long term. The S&P 500 represent 80% of all stock market capitalization. Included in this mix are stocks from other specialty funds and companies who get revenue from global markets.
Another fund is The Dow Jones Wilshire Total Stock Market Index, which represents nearly 5,000 stocks. The total stock market. In the short term the returns may be different. Over the long term both indexes generate similar returns.
The important point here is that index funds have no or low fees. Index funds are what the industry uses to judge its success. Over the long term, very few fund managers beat the indexes. We’ve all seen impressive advertisements that show certain funds beating the market with returns of 25% or more. These are for relatively short periods of time and an event rarely seen for the long term. It’s impossible to know, out of the multitudes of mutual funds, who these mangers will be.
Statistically, all funds will return to the mean. So a fund that beat the market with 25% returns for a few years will likely earn 9% or below in the next years. It's a mathematical law called 'mean reversion'. Past history is no predictor of the future.
Risk is the most important dynamic is determining your investment approach. We all know higher risk equals higher returns. We can hold risky assets in our portfolio as long as we have other investments to achieve some balance. An equity mutual fund will contain risky assets. That risk will be offset by other stocks within the fund.
Holding similar funds present a risk because these funds may rise and fall together with the market. If you want diversification, in addition to an index fund, an international fund is a perfect addition. Why?
A professionally managed international fund gives you access to great opportunities...not to mention the ability to take advantage of our declining dollar. U.S. stocks and international stocks are not correlated. If the S&P 500 fund should fall, the overseas fund can rise.
Some sector funds will have good long term potential. Of course choosing that sector depends on you view of the future. Not past returns.
I'm bullish on energy and commodity funds. Everything I know about these two sectors tells me: Energy costs will continue to rise. And..... The world (especially China & India)will consume more commodities.
Until we heat our homes entirely from the rays of the sun, energy funds are a good long term play.
Your game plan should be to buy an index fund and hold it over the long term. Start early and let compounding interest within a no-load fund do its stuff. Don’t freak out if the fund loses some value over the short term.
In the short term, stock prices will rise and fall based on factors that have nothing to do with the value of the company. But everything to do with the emotional buying and selling of the crowd.
When you find a fund you like, stick with it. Over the long term, you won’t beat the market with an index fund. You'll do just as good. You will make more money than your friends who invest in specialized contrarian funds whose CEO’s eat vegetarian. This is becuase your fees will be lower. You even make more than your pals who plan to day trade over the next 10 years. Your transaction costs will be lower.
What about stock trading? Should I just give that up and turn my life over to mutual funds? Of course not. A fund can never capture the excitment of grabbing a 25% return on a $5 stock in under three weeks.
And at my age, I could use all the excitement I can get.
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