4 Mistakes to Avoid When Choosing Mutual Funds
Mutual funds are the go-to investment option for many people starting the journey of investment or for those looking for more investment opportunities. A mutual fund exposes you to a wide variety of industries and you do not have to do the heavy lifting of picking out individual stocks. However, all mutual funds are not equal. If you pick out the wrong one, you may end up paying ridiculous fees or worse still, investing in a sector that will eat up your returns. Here are the mistakes you should avoid when picking out a mutual fund.
Paying Too Much in Fees
The fund determines the amount of fees you will pay. Mutual funds that are actively managed or those that have their stocks picked by a fund manager obviously have higher fees than passive mutual funds, like an index mutual fund. There are more fee differences apart from this one. Some funds pay a commission to brokers when they sell the fund to an investor. This commission is referred to as a front-end load; it can be as high as 5% of your invested assets and you pay it upfront.
Again, when you sell the fund you are charged a fee known as a back-end load. The sooner you sell the fund, the higher the fee will be. If you want to pay as hardly any fees as possible, invest in a no-load fund—it usually has no commission when you sell or buy the fund. If you do not thoroughly evaluate the fees associated with a fund, you risk diminishing your returns.
Chasing Past Performance
Many investors invest based on past performances, hoping that history will repeat itself. Past performance does not determine future performance. Just because a fund has been doing well over the past couple years is not an indication that it will always perform well. Consider the time horizon, the exposure and whether it matches your risk tolerance and, of course, what the fund actually invests in. Past performance should only help you narrow down your choices but it should not be your main reason for choosing a fund.
Not Considering Tax Implications
A good number of investors invest in mutual funds using retirement accounts sponsored by their companies. Nonetheless, they will also choose to invest outside these retirement accounts. If these investors are not careful, a tax event may occur. Any mutual fund that has a high turnover rate, for example, will attract more tax events.
Being Ignorant to Redundant or Overlapping Investments
Far too many investors think that once you invest in a mutual fund, you have nothing else to do. They forget (or are unaware) that a fund has underlying investments. People with a single mutual fund may get away with this but if you have invested in different funds (for diversification purposes), you have some work to do.
Obviously, all your mutual funds do not have the same investments. The reason for investing in multiple funds is so that you can be diversified.
