So you want to invest in mutual funds? Join the crowd.
Thanks to the booming stock and bond markets, mutual funds are hot. There are more than 2,000 funds--almost quadruple the number in 1980--with new ones created almost daily. Mutual funds boast about 27 million shareholders, with total assets of about $800 billion.
The advantages of funds are simple. First, they provide diversification. For initial investments of as little as $100, investors can buy shares in a fund that
may invest in hundreds of different stocks and bonds.
Funds also provide convenience and professional management ex-
pertise, saving you the time of monitoring today's volatile mar-
kets. They also provide a variety of investment options. They can be broadly diversified, like the Van-
guard Index Trust, which invests in all stocks in the Standard & Poor's 500 stock index. Or they can be narrowly focused, like Fidelity's Select Portfolios, which invest in stocks in just a single industry, such as energy or leisure.
But funds have their pitfalls. Fees charged to buy and sell funds have been growing. Also, the proliferation of funds makes choosing one as bewildering as choosing individual stocks.
One of the biggest pitfalls is risk. The recent slump in stocks and bonds hurts share values, surprising some investors who thought their funds were relatively risk-free. Further market declines could lead to additional losses. And like other investments, there are no free lunches with funds. If you want higher yields, you generally must take more risk. And although funds have generally performed well during the past five years, they generally have underperformed such major market indexes as the S&P 500.
So how should you steer through this fund mine field?
Because no one knows for sure where stocks and bonds are head-
ed, "our philosophy is that every-
one who invests in mutual funds should be long-term investors" and think of them as five- to 10-year investments, said John Markese, director of research for the Ameri-
can Assn. of Individual Investors. Most investors are not good at timing short-term ups and downs in the markets, he said.
Michael D. Hirsch, author of "Multifund Investing," a book outlining the basics of fund selection, says investors often fall into three traps.
The first, which Hirsch dubbed the "current craze," occurs when investors go with the crowd and invest in whatever type of funds are in vogue at the time. Those funds aren't likely to remain hot, he said, noting that the group now in vogue, international funds, "will soon be falling apart."
The second trap, dubbed the "cult of performance," occurs when investors pick one of the Top 10 funds for the past quarter or year. Such rankings give no indication as to how those funds will do in the future, Hirsch said, noting that four of the top 10 funds in 1983 plummeted to the bottom 100 the next year.
"Too many people just look at the last year and try to pick the highest-ranking fund," Markese said. "It's consistency of performance in different markets, risk adjusted, that really counts."
The third, dubbed the "trap of random selection," occurs when investors pick funds without much research, figuring that all funds will do well. In reality, however, there is a wide disparity in per-
formance, investment objectives and risk among funds, Hirsch said.
Thus, experts say, the first step in choosing a fund is to decide on your investment strategy and needs. If you want to take more risk and don't need current income, consider aggressive growth or growth funds. These funds invest in stocks expected to rise in price instead of pay large dividends. High rollers also might consider precious metals funds, the top performing group in the first quarter of 1987.
If you think interest rates are headed down soon, longer-term bond funds might do the trick. The bonds in their portfolios will rise in value with lower interest rates.
But if you are more conservative and need steady income rather than capital growth, consider income funds and balanced funds. They own combinations of stocks and bonds that produce high current income.
If you think the markets are going downhill, or if you just want to park some of your money where
it faces little risk, try money-
market funds or short-term bond funds. They invest in short-term credit instruments, such as Treasury bills, which have little or no risk of declining in value if interest rates rise.
Next, research the marketplace for individual funds that meet your investment goals. If you simply have no time, a broker or financial planner will recommend funds.
However, many brokers and planners will steer you to so-called load funds, which charge up-front sales commissions that can run as high as 8.5% of the value of your investment. By researching funds on your own, you can avoid such charges by buying shares in a no-load fund.