Before selecting a mutual fund to invest in, it’s important to spend some time thinking about your objectives for the particular investment.
Mutual funds are typically classified according to the types of assets they invest in. There are three main types of mutual funds: stock funds; bond and income funds, and balanced funds. As the names indicate, a stock mutual fund invests predominantly in stocks, a bond fund in bonds, and a balanced fund strikes a mix of both. Stock funds typically carry more risk than bond and balanced funds, and are better suited to investors who may be willing to accept a higher level of risk in order to improve their potential returns. More conservative investors may wish to focus on bond or balanced funds, depending on their investment objective and the level of risk they are willing to accept.
So where do you fit on the scale, and how might that impact your choice of fund? Here are some basics to consider:
- Protecting the value of your investment is your main concern, while potential returns are secondary. If this describes your objectives, then you are looking for a conservative investment. You are hesitant to take on risk, to the point that you are willing to accept limited returns over the possibility of losing a large portion of your money. You should give a higher priority to low volatility, predictability and consistency of returns. Bond funds are generally an attractive way to meet this objective.
- Protecting the value of your investment is important to you, but you’re willing to accept higher risk to increase potential returns. This describes a stable investment that is moderately conservative. Your primary focus is to limit the volatility of returns; you are however willing to accept some risk in order to earn a higher return (compared to preserving capital). Higher risk diversified bond funds or lower-risk balanced funds are attractive choices to meet this objective.
- Protecting the value of your investment and higher potential returns are equally important to you. This points to a “balanced” investment which aims for a middle ground between preserving money and growing it. You are open to taking on a moderate level of risk, and are more concerned with the potential for modest growth than with predictable returns. Hybrid funds or balanced funds are attractive choices to meet this objective. The relative weighting of stocks and bonds in the fund will depend on your risk preferences and the length of time you plan to hold this investment.
- The longer-term potential returns of your investment are more important than protecting the short-term value of the investment. This represents a “growth” investment that focuses on achieving higher possible growth. In order to do so, you must be willing to take on a greater amount of risk. Higher-risk balanced funds and lower-risk stock funds are attractive choices for this objective.
- High longer-term potential growth is your main concern, while protecting the short-term value of the investment is of low importance. If this is what you seek, then an “aggressive growth” investment may be for you. This type of investment focuses aggressively on achieving the highest possible growth. In order to do so, you must be willing to take on a significant amount of risk. High-risk stock funds are attractive choices for this objective.
So before you jump in, take time to consider which of the above best describes your objectives for your particular investment. It’s a fundamental step towards to making a fund selection that is better suited to your specific preferences and goals.
