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What
You Should Look For in a Mutual Fund
By Barry Habib
When
shopping around for mutual funds, you don't want to pay a sales
load or a sales commission. The funds without a sales charge have
not proven to perform any worse than those with a sales charge.
So don't wind up paying 3% or 6% as a commission when it's not necessary.
Look for no-sales-load type of funds so that every dollar you invest
is working for your benefit.
There are three other fees that don't jump out at you as quickly,
but they must be disclosed. You can find them while looking over
the prospectus which is the full disclosure of the mutual fund or
by discussing what charges a fund has with a representative of that
particular fund over the telephone. First, find out if the fund
has any redemption fees, meaning that if you liquidated your account
or took out a portion of your account, would you be subject to any
penalties at that time. There are plenty of terrific performing
funds that do not have this negative feature. The second thing I
would look for is that the fund does not carry any what are called
12b-1 fees. This is an asset based fee. It has no direct relationship
to investing money in the fund or taking money out of the fund,
but periodically, the overall assets of this fund are charged a
fee. This is a fee that pays for all the advertising material, publications,
public relations and things of that nature. Most funds do not charge
a 12b-1 fee.
The last thing that I would be aware of is the expense ratio that
each fund carries. It's basically how the fund makes money. Included
in the expense ratio are fees for the professional management, marketing
fees, customer service representatives get paid from that overall
expense fee that gets charged and other things that the fund needs
to charge to carry on its day-to-day operation. That fee should
be approximately 2% or less. If there's a fund with a higher expense
ratio, ultimately that will hurt the performance of the fund and
there are several funds that are terrific performers, once again,
with fees or around 2% or less. Certainly don't get involved with
a fund that has expenses of 3% or 4% or greater. That's just way
too high a price to pay and it will adversely affect the return
you receive on your money.
If you're new in the mutual fund game, where would you be able to
compare these funds? And where would you be able to become more
educated? There are several wonderful and affordable publications
which compare different funds and give several recommendations.
Try Money magazine, Kiplinger's Personal Finance, or Forbes. Another
alternative is to check out Morning Star rankings or Lipper Analytical
Services' rankings. These services also rank funds based on risk
and performance.
Mutual fund rankings are based on different time categories such
as one years' performance, 3 years, 5 years or 10 years. When you're
comparing these funds, if you just compare them by last years returns,
that might not be the best thing to do. If the fund had a tremendous
year, chances are that fund might go through what is called a correction.
I wouldn't necessarily buy a fund that's been performing exceedingly
well in the past year. What's wiser to do is take a 3 or 5 year
history and see how that fund has performed over a longer period
of time and look at the long term performance of the fund's manager.
Most stock funds are compared to an index such as the S&P 500.
S&P stands for Standard and Poor's which is a company that selects
different stocks for their portfolio. The S&P 500 represents
the top 500 stock picks of the S&P. Many equity funds use the
S&P 500 as a gauge of their own performance. Since most equity
funds are tracking the S&P 500, trying to top the S&P 500's
performance, why not consider investing in a fund that just tracks
the S&P 500 or simulates it exactly.
Tips
on How to Invest Your Money
The
way that most people invest is in a lump sum. That might not always
be the best way to go. Another thing is that as the investments
do well, and as the returns become greater and greater, the human
tendency is to want to chase the returns and keep adding a lot more
money to a fund that's performing exceedingly well. When the market
itself or a fund is doing poorly, human tendency is to either stop
investing or worse, take money out of the fund. Our human tendencies
are contrary to successful investing.
Since 1920, there have been 10 bear markets, meaning that the market
has declined by 20% or more. However, what's very encouraging, is
that the market has always recovered. Now it might have taken 6
months, or a year or maybe even two years, but once again, the market
has always recovered its losses and then moved further to higher
gains.
Let's look at the October crash of 1987. The Dow Jones Industrial
Average, which is the most widely-quoted stock index in the world,
represents the overall performance of the United States stock market.
Back in October of 1987, the market was performing exceedingly well
and the Dow Jones was up to a level of approximately 2300. In a
short 2 days, the stock market lost over 600 points, 508 of that
in a single day. Many investors panicked and many investors withdrew
all their money from the stock market, being worried about the crash.
However, by mid-1994, the Dow Jones Industrial Average stood at
about 3700 points. So the market went from 1700 to 3700 over a 6
year period, reflecting about a 61% gain. The appreciation is actually
much greater than that when you account for reinvested dividends.
When the Dow was at 1700, just prior to that it had been performing
exceedingly well. Therefore, it was due for the inevitable correction.
When that correction in the market occurs, most people panic and
take their money out. However, that's the exact time when you should
be investing more because the market will invariably recover. Those
individuals who withdrew their money or failed to invest when the
stock market was at that low 1700, made a critical mistake because
they missed out on the 2000 points of appreciation and dividends
that followed over the next several years.
It's also our tendency to take money out or stop investing at the
exact time when we should be adding more money. There's a gentleman
by the name of John Templeton. He is considered to be one of the
deans of investing. Mr. Templeton says that the best possible day
to invest is the day when the market seems the most pessimistic
- when it seems that the market is the worst place to be. Mr. Templeton
also says the worst time to invest is on the day where the market
seems most optimistic or when it feels like nothing can go wrong.
So based on this information, which is the opposite of our human
tendencies, I would like to introduce you to a system called "dollar
cost averaging." Now dollar cost averaging is a very interesting
way of investing. It's a disciplined way of doing it and it can
be set up for you automatically with an automatic withdrawal from
your checking or savings account by virtually all mutual fund companies.
Rather than investing in a lump sum, you invest in equal monthly
amounts. This will automatically buy more shares when the price
is lower - when you should be buying more - and buy less shares
when the price is heading higher - when you should be buying less.
Dollar cost averaging is a wonderful way to put your investments
on automatic pilot. And that's the way you should invest. You should
stick to your long-term plan and not get caught up in the inevitable
interim market lows and highs. Stick to the system that has a proven
track record. You have to remember that this is long-term investing.
You have to understand going into this that there's going to be
times when your returns will be negative. There will also be times
where your returns will be tremendously higher. But neither of these
is an accurate picture. It's over the long term - 5, 7, 10 years
or more, that's when you'll see true appreciation and true value
for your patience and systematic investment.
The
Magic of Compound Interest Can Work for You
The
Rule of 72
72 ÷ The rate of return =
The number of years it takes
for principal to double.
You
may have heard of the rule of 72. The rule of 72 says that if you
take the number 72 and divide it by the rate of return you'll be
receiving on your money, that will be the number of years it will
take for your money to double. For example, if you're receiving
12%, 72 divided by 12 equals 6. Therefore, it will take 6 years
for your investment to double. If you invested $10,000 at a rate
of 12%, 6 years from now it will be worth $20,000. 6 years later,
or 12 years from today, when you started, it will be worth $40,000.
6 years after that, it will be worth $80,000. So money will double
in the amount of years that interest rate goes into 72. Now that
can happen pretty rapidly. And what makes it happen rapidly is the
magic of compound interest.
EXAMPLE
Take
an 8% rate of return
72 ÷ 8 = 9
At 8%, money will double every 9 years
$15,000 in 9 years = $30,000
In 9 more years = $60,000
In 9 more years = $120,000
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