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1997-98: REVIEW AND OUTLOOK

The Basics of Mutual Fund Investing

The Choices Are Overwhelming, the Steps Fairly Simple

January 04, 1998|RUSS WILES | SPECIAL TO THE TIMES

Some people don't know where to start buying mutual funds, so they keep their money in banks, waiting for the right moment.

Others accumulate mutual funds as they would knickknacks. They buy a little of this and a little of that, until they own a jumbled assortment of things that may not work well together.

Even sensible investors who have prudently divided money among a few funds and been happy with the results are often uncertain whether they've done the right thing.

To be sure, trying to select mutual funds can be a maddening exercise. It's as much an art as a science.

For starters, it's simply impossible to predict with any certainty how the stock and bond markets that funds invest in will behave in the future. It's almost as challenging to foretell which funds will beat the market averages and which will lag them.

Performance can be disrupted by many other factors--your fund's manager might resign or your fellow investors might pull their money out, requiring the managers to sell prematurely.

Nonetheless, you needn't be paralyzed. You can proceed with a general plan of attack and build a portfolio that makes sense for you. The mutual fund charts published today on D12-15 can help.

Here's how to get started:

Narrow the Choices

Many novice investors undoubtedly feel overwhelmed by the vast number of mutual funds available--more than 6,000. But hundreds of these selections--probably thousands--may be inappropriate for you and can quickly be disregarded.

For example, if you are mostly worried about keeping what you already have--which means you seek "capital preservation" and would be happy with the current income that money produces--forget about aggressive small-company-stock funds.

If you require long-term growth, cross out money market funds and conservative bond funds. If you plan to research, select and monitor your own investments, disregard those funds that are sold at a higher cost or "load" by brokers and financial planners.

Decide Your Risk Tolerance

A big part of the process boils down to learning--or at least recognizing--what type of investor you are.

* Do you seek appreciation or stability?

* Can you let your money ride for many years or just a few months?

* Would a bad year in the markets cause you to lose sleep, or would you shrug it off as a temporary setback?

If you work with a broker or financial planner, your advisor will probably start off by quizzing you about your goals, fears and temperament so he or she can draw up a list of suitable investments. But you can also test yourself by completing one of the many investor profile quizzes offered by larger mutual fund companies, either in pamphlet form or over the Internet.

Key variables include your general financial status, tax situation, investment sophistication and time horizon (the number of years before you need to spend the money).

"You have to be careful not to put short-term money in the stock market," says Kurt Brouwer, an investment advisor and author in Tiburon, Calif. "I think some people are doing that now because they think they can keep the money in for a year, earn 18%, then buy a house. We tell long-term investors that they should be thinking in terms of a 20-year horizon, if not more."

Another critical consideration is your risk tolerance, or ability to stomach market fluctuations. The key to investing is sticking with a plan long enough for it to bear fruit. That means accepting the inevitable downdrafts as part of the process.

"If you have $100,000 invested in stock funds, ask yourself how far your portfolio would have to drop before you became inordinately uncomfortable," suggests Joe Duran, senior vice president at FundMinder, a Sherman Oaks company that manages mutual fund portfolios for clients. "Of the people we work with, roughly 80% indicate they would head for the doors after a 10% drop."

Even when you know your appetite for risk, it's important to understand that risk measurement is itself an uncertain endeavor that is generally based on what has happened in the past. The future may be different, whether because of slow changes in the nature of the economy or major technological breakthroughs--or disasters.

That said, the reason the stock market is expected to continue performing better than the bond market or bank accounts in the long run is that stocks represent ownership in companies that tend to grow with the economy itself. Bonds and bank accounts are simply loans, albeit with higher interest rates paid for higher risk, but those loans give you no chance to share in the profits of the companies or banks that borrow the money from you.

Yes, there is a risk that stocks will perform poorly for many years and not recover in your lifetime. But there is also a risk that if you are not invested in the stock market, you will miss out on bursts of increasing profits and economic growth or simply fail to keep up with inflation.

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