What are the best mutual funds for beginners? That is a very complex and daunting question. To come up with the right answer for you, certain questions need to be answered first. Then, basic criteria should be used in making a decision.
The first question for you to answer is what type of investing do you want to use the mutual fund for? I will eliminate those who are participating in a company sponsored investment program. If you are fortunate to have a 401K offered where you work, be sure to participate. Your company should also provide information and advice to help you make the appropriate selections for you. Take advantage of the services that are offered.
Most beginners want to invest in mutual funds to get their feet wet in the investment arena and minimize the risk of losing capital. This is a wise move, as educating yourself about how mutual funds are set up and how they do their investing will provide knowledge that can transfer to stock investing.
One of the drawbacks to mutual funds is the expense load they charge. This is to cover the management of the fund and bookkeeping. This charge can range from 0.19% to 2.00% or more. This will eat into your return. I will address this later.
The motivating factor should be to save money and have it grow with small risk. Some funds allow you to start investing with as little as $500. However, your investing timeline will drive some of your choices. Each mutual fund has certain characteristics and objectives they strive for. They usually fall under the following categories:
- Index – matches shareholding of a specific index like the S&P 500 or the Dow Jones. These funds match the overall market performance
- Sector – concentrates stocks from companies in a specific sector of the economy. Examples include transportation, health, energy, and consumer goods. Results from these types of funds can vary widely and is dependent on the overall conditions of the economy.
- Global/International – these funds focus on international companies, although they may include some US based companies. These tend to be more volatile than funds with only US stocks.
- Bond – these funds are made up of bonds and are usually called fixed-income funds. They target interest income.
- Balanced – these type of funds have a mix of stocks and bonds. They strive for a more stable return.
Now that we know the various categories of funds, we now need a way to narrow down your selection. The following
Criteria are key to helping you make the selection.
- Consistency with your investment goals – do you have issues with investing in oil companies? What about tobacco producers or casinos? Do you have issues with major agribusiness. If you do, investing in mutual funds will be difficult. The whole purpose of mutual funds is to diversify the risk. This is done by investing in a lot of different companies. It is up to you to make sure you know what companies/industries your fund is investing in and you are comfortable owning part of those companies.
- Fund strategy – is the fund strategy of colleting interest and preserving capital at all costs what you want? This will limit your return, but minimize the risk of losing your initial capital. Are you a risk taker? Then a Global or International Fund may be what you are looking for. They can have a higher rate of return, but there is a greater risk of losing some of your capital.
- Volatility – slow and steady or peaks and valleys? My recommendation for beginners is to have low volatility in the fund you choose. Until you have some investment experience, and get comfortable with volatility, stay away from it.
- Tax efficiency – for most beginners, this will not be an issue.
- Manager tenure/turnover – look for funds that have management that has been with the fund over 5 years, better yet, over 10 years. This is an indicator the fund will continue the same investment patterns and should achieve similar results as in the past.
- Fund Fees – this is the biggie. The lower the expense load, the more money you get to keep. As a rule of thumb, look for a fund that has an expense load of 1.50% or less. If it is going to cost you more, then make sure you understand why the fees are higher and are you going to get additional returns. Also, look for funds that are no-load. No-load funds do not have a sales charge.
One of the best places to do your research is at the Morningstar website. Sign up and you can use their free screener to help you find the mutual fund that is right for you.
If you are overwhelmed with information, then I have a recommendation. Go to the Vanguard site or Fidelity site. Both have friendly websites and are used to dealing with new investors. Both have low fees and a variety of funds to choose from.
Depending on the amount of money I had to invest, going with one or two Vanguard or Fidelity funds would be the way to go. The Vanguard STAR Fund has a $1000 minimum to invest, 0.34% expense ratio and good performance. Fidelity has about 10 funds that are candidates for investing. Most start with a $2500 minimum and the expense ratios are closer to 1.0%. My preference would be to start with Vanguard. They have the lowest fees and have been around a long time.
Key to successful investing is to make sure you understand what risks you are taking and how much you are paying for the services being provided. Starting with Vanguard or another large fund that deals with new investors is the best place to start. They will help you with your education.