What You Should Know About Mutual Funds And Exchange-Traded Funds
Financial planning and investing aren’t rocket science. It all boils down to this: set your goals, establish a smart, realistic strategy, and stick to that plan for the long haul.
Of course, when it comes to “buying” investments for your retirement account, you should be an educated consumer. There are thousands of mutual funds and ETFs to choose from when building your 401k or private retirement account. Many of these are aggressively marketed to the public. A basic understanding of fund traits will help you make better decisions, whether you are managing your own investments or working with a financial professional.
Here are some things to consider as you evaluate a mutual fund or ETF for your portfolio.
What’s the fund’s strategy?
The two categories of stock mutual funds/ETFs are growth and income. While both types focus on maximizing returns, their strategies are very different.
Growth vs. Income
Growth: Growth Funds offer the potential for higher returns with higher risks; they often perform in tandem with the overall stock market and do better when stock prices are rising, and can suffer when stock prices fall. These funds are comprised of shares in companies that focus on expansion and increased market share, and are best suited for higher risk tolerance and a longer time horizon. Netflix and Amazon are two good examples.
Income: Income funds, by comparison, are relatively conservative investment vehicles. Income stocks pay dividends that can be reinvested to turbocharge the growth of a retirement account. Income stocks tend to be shares in well-established companies in mature industries. Think Proctor & Gamble or Apple.
What’s the Expense Ratio?
The expense ratio is a measure of what mutual funds and exchange-traded funds charge shareholders to offset the fund’s annual operating expenses and is expressed as a percentage of the fund’s average net assets. Expense ratios vary widely based on the investment category, investment strategy and the size of the fund, with smaller funds tending toward higher expense ratios. You can compare the expense ratio of funds by looking at the fund’s prospectus, financial news websites, fund screeners and news journals.
How long has the fund been around?
When considering funds for your 401k or other retirement account, the life of the fund can be an indicator on how much to allocate to a particular fund. Newer funds carry more risk, as they may not have experience with market fluctuation, but they also carry the possibility of higher returns. Conversely, older, more established funds can sometimes weather the storm of a poor market more easily than their youthful counterparts.
These questions will serve as an excellent starting point for exploring a fund’s suitability for your portfolio. If you are working with a professional, ask these questions – and lots more -- before accepting her recommendation. If you are a DIY investor, scour the web for the answers, and additional background.
After all, we’re talking about your future here. You should know at least as much about your investments as you did about that 75-inch TV you bought last winter, right?
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