***There may be affiliate links throughout this post. Please refer to the disclaimer page for additional information.***
Are you wondering what the best way is to invest in mutual funds? It’s quite simple. You want to make the math work for you as numbers do not lie. Fortunately, there are 2 key metrics that you can use to determine how profitable a mutual fund is.
But first, let’s cover off on a few basics.
How Do Mutual Funds Work?
A mutual fund is a collection of stocks, bonds, money markets, etc. Essentially, this allows you to diversify your portfolio with one fund.
Be careful though. While a mutual fund is dividing your money up among multiple companies it is often focused on one area of the market. For example, if the market in general is good but international companies are tanking, you don’t want to only be invested in one mutual fund focused on international companies.
Fortunately, you can invest in several of the best performing mutual funds and further diversify your investment portfolio. Most investment portfolios will have a wide selection of mutual funds to choose from. Mutual funds range from small, mid or large cap, growth, international, low-cost index, bonds, balanced funds and more. Knowing how to buy mutual funds that are profitable is important.
Passive vs. Actively Managed Mutual Funds
Depending on the type of mutual fund you invest in, it may not require much, if any, active management from a financial institution. These types of mutual funds are known as passive mutual funds.
Index funds are a great example of passive investing. Index funds are designed to track a certain market index, like the S&P 500. Because of how an index fund is designed they do not require much management which results in lower fees.
Other mutual funds require more active management and often have higher fees. With these types of mutual funds there is usually a board of directors or trustees that monitor the fund and make decisions based on shareholder interests.
These days there is so much talk about index funds being a great investment option because of their low fees, that it’s easy to overlook other great fund options in your investment account(s). Click to tweet this.
Many index funds offer low fees with high returns and can be a great option, but they may not always be the best available option in your investment account(s). Don’t get caught up on the index fund bandwagon without doing your homework first. You may be surprised by what you find.
Long term investing is all about the numbers and numbers don’t lie. If you’ve never been good at math don’t let the numbers scare you. There are many advanced calculators available for free online to help you calculate what one investment path will generate over time verses what another investment path will generate.
Wish you had more money to invest? If you aren’t already tracking your monthly expenses, you are likely overspending in a few areas.
Grab this monthly expense tracker today and start cutting costs. This tracker goes well beyond your ordinary expense tracker.
This tracker will help you:
- start trimming your current budget
- have more money to invest
- determine how much money you will need to retire
If you prefer paper and pen over spreadsheets, try this budget planner instead.
The Best Performing Mutual Funds
The 2 key metrics to determine the best mutual funds for beginners are 1.) fees and 2.) the performance of the fund. First, you want to compare how well a fund is performing when compared to other funds in a similar class. Then, you want to review the fees associated with a fund.
Fees can make all the difference in the success of an investment. The higher the fee the less there is to continue reinvesting over the long run. This is crucial thanks to the power of compound interest.
What is compound interest? Compound interest is where the interest on the money you have invested in a retirement account earns interest. Over time, that interest will earn interest and the cycle will go on forever until the funds are completely withdrawn.
The higher the annual return on a mutual fund, the faster your portfolio should grow.
A fund’s prospectus (a performance report issued by the financial institution offering the fund) will show the annual returns on that fund over several time frames. You should be able to find a fund’s prospectus by searching the internet using the funds name and the word “prospectus” in your search.
A fund’s long term history in performance gives us the best picture of how well the fund will perform in the years to come. The more current time frames should give us an indicator on how the market is in general at the moment.
If you’re looking at a fund that doesn’t follow the trends of other funds, that is probably a warning sign to stay away. Or perhaps, you have mistakenly started researching a mutual fund full of bonds. Returns on bonds tend to increase in a bad economy and decrease in a good economy.
In the below example, both options have good returns, but the 2nd option is the best. However, option 1 could be the better choice if the fees are significantly lower with option 1 than option 2.
A Mutual Fund’s True Growth Potential
To understand the best performing mutual funds you must look at both the annual returns and fund fees. When the fund fees are high enough, it could make a fund with a slightly lower annual return the best investment option.
Use this simple calculator to determine 10, 20 and 30 Year Balances (for the calculator’s Return Rate use Annual Return less Net Fund Exp %). The first fund, in the example below, will generate greater returns than the second one even though its annual returns are lower. The higher fee associated with the second fund hurt the actual long term growth potential.
The impact is not as significant over 10 years, but the benefit is clear over 20 or 30 years of investing. Even with 10 years, there’s a couple nice vacations to be had during retirement with the additional $6K in savings from selection 1.
Take the Investment Challenge for Beginners
Put this knowledge to the test and make sure you are investing in the best available options in your portfolio.
You will learn how to understand the true profitability of a fund. The growth of a fund is just as important as the fees associated with it. By the end of the challenge, you will be able to tell where your current investment funds rank against other fund options available in your portfolio.
Determine Your Desired Investment Portfolio Mix
The longer you have to go until retirement the greater risks you can take. The older you are the more conservative you should be by investing in lower risk funds (typically bonds).
The old rule of thumb was to take 100 subtracted by your age to determine how much your portfolio should be invested in stocks. For example, if you are 40, then you would invest 60% of your portfolio in stocks and 40% in bonds.
As people are living longer and bonds have lower returns than they used to, this may no longer be the best portfolio mix.
Most financial institutions offer age based investment funds based on the year you expect to retire. If you decide to go this route, it’s important to note financial institutions use different stock/bond ratios for their age based investment funds. So, if you choose this option make sure you understand what that ratio is and how it aligns with your tolerance risk.
If you have limited money saved and can’t risk losing it, then putting a larger portion of your retirement account in bonds may be right for you.
Review Mutual Funds to Invest In
The only way to know if you are investing in the best options available by your financial institution is to review their investment fund chart. You will want to size up your current investments with the best options available. If you aren’t familiar with investment charts, they may seem overwhelming at first. Rest assured investment charts are not that difficult to read.
Looking at the chart below, which is based off real data, the best performing investment options are selections 1, 5 and 7.
Selection 1 is an index fund and offers the lowest fee. Selection 7 is a growth mutual fund and has the highest returns.
The return rate for:
- selection 1 over 10 years is 15.30 (15.34 in total gains – 0.04 in total fees).
- selection 7 over 10 years is 16.30 (16.82 – 0.52).
The growth fund has a 1% greater return over 10 years compared to the index fund. As we reviewed above that is a substantial difference over time.
Worth noting: selection 2 is an index fund that tracks bonds. The returns are lower on this because the risk is lower and ideal for someone getting close to retirement.
Keeping in mind your desired portfolio mix between bonds and stocks, everyone should be able to do this type of review to determine the best investment options offered by your financial institution. Not all financial institutions are created equally.
There is a broad range of what might be or might not be offered by your financial institution. In some cases, you may get a better return rate at a different financial institution.
In which case, you may want to consider rolling over your retirement account from your current financial institution to a different financial institution. This can only be done once within a 12 month period per account. Additionally, money in a 401K plan can only be moved after the funds have been invested for 2 years.
There are a few hoops to jump through but usually they aren’t too difficult to overcome.
Re-balancing the Mutual Funds You Invest In
Assuming your investment portfolio is invested in more than one mutual fund, you will want to re-balance your account. The percentages you set your account up initially changes as the fund with the largest growth starts taking up more than the percent you set it for.
You could set your retirement account(s) to automatically re-balance at set intervals. Standard intervals are every 3 months, 6 months or yearly. Alternatively, you could do this at your own pace.
However, unless you are actively watching and monitoring your investments, setting the re-balance to happen automatically is the best option.
Congratulations! You now have all the basic tools to understand how to invest in mutual funds. So, what are you waiting for? Go and review all the investment options your financial institution has to offer and see if you should make some changes.
Don’t put it off. Do it today! The longer you wait the less likely you are to do it. This is your future. You should control it.
Beyond Mutual Funds
If you are not completely confident you are currently investing in the best performing mutual funds in your investment portfolio, then the investment challenge is right for you.