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Are you confident about how to invest in mutual funds? Investing in mutual funds can feel overwhelming in the beginning. However, once you understand how to evaluate 2 key metrics of a mutual fund it’ll be much easier.
Mutual funds come in all shapes and sizes. Most retirement 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 invest in these mutual funds is important.
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 retirement 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.
A Mutual Fund’s Overall Performance
The 2 key metrics of a mutual fund’s overall performance are fees and the performance of the 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.
- The other important aspect to investing wisely is how well the fund is performing and how it compares to other funds.
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 growth potential on a mutual fund 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.
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 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.
Roll Over Your 401K, IRA of Brokerage Account
The money you have invested in a 401K, IRA or brokerage account can be rolled over to a different financial institution if you so choose. 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.
Aside from deciding where you want to move your money to, you will have to fill out a transfer form from your current financial institution. Depending on their requirements, you may need to get a medallion signature. This is similar to needing a notary signature except this is only available through banks or financial institutions.
Most major banks offer the medallion signature service free of charge. It may not be available at all bank branches so call ahead and make sure an authorized signatory is available to sign your document before you go.
There may be fees associated with the sale of stocks and bonds in the account you’re moving your funds out of. The better return rate where you’re transferring your funds over to should make it worth the fees over the long run.
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
While you are at it, make sure you are saving enough to retire and on time when the day finally arrives. This article is only a small part of making sure you are prepared to retire when the day comes.
The Ultimate Retirement Savings Plan Road Map
Most Americans recognize they’ll need at least $1,000,000 to live comfortably in retirement. However, according to a TransAmerica Center study, over 35% of Americans do not have a retirement savings plan and only 19% have a written strategy.
Don’t be one of those people. This series will walk you through the importance of planning ahead for retirement all the way through how you can boost your current investment strategy.
Take control of your future by planning wisely. It’s never too early! In fact, the sooner you start the better off you’ll be.
- Understand the importance of having a retirement savings plan that meets your needs, not the average person’s needs.
- Review your current expenses and see if you can cut costs anywhere to save faster for retirement.
- Use your current expenses to estimate what your expenses will be like in retirement.
- Plug your unique and individual estimated retirement expenses into 2 tested guidelines to calculate YOUR ultimate retirement savings goal.
- Discover why a Health Savings Account (HSA) is the gold standard for retirement savings and how to make it work best for you.
- Understand the different types of retirement accounts and which ones are the best for you to invest in.
- Learn about costly mistakes you will want to avoid when you invest your money in retirement savings.
- Wrap your head around the fees associated with investing, particularly avoidable ones charged by a financial adviser.
- Understand the different types of mutual funds available and how to determine which one(s) are the best to invest it.
- Review your investments and explore ways to know if they are working for you.
Retirement Expense Planning Worksheet
Use this expense tracker to record current expenses and estimate future expenses. This tracker includes tips on how certain expenses will change for the better or worse in retirement. Get started recording your current expenses today and feel better prepared for tomorrow.