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Monday, December 28, 2009

Mutual Funds to Avoid

Mutual funds are a great way for most investors to invest in stocks, bonds and the money market. Some are better than others, and some should be avoided altogether.

You should not be trying to hit a home run when you invest in funds. Rather, your objective should be to participate in the markets to get overall returns that are higher than you can make at the bank, and more consistent than you could get by playing the stock market or bond market on your own.

To give you some perspective ... historically, over the long term stocks and stock funds have returned about 10% to 11% a year, bonds closer to 5% to 6%, and the safest investments (like T-bills and savings at the bank) have averaged about 3%. Over the past 50 to 80 years, inflation has averaged about 3% a year as well.

Avoid mutual funds that do not have well-established track records. Why take a chance on a fund that has not proven itself? If you want to take chances, play the market. Every mutual fund's literature tells you when the fund was established, and shows its historical performance.

Avoid funds with erratic performance records. For example, you want your largest stock holding to be a stock fund that pretty much tracks the stock market. If the market was up 10% for the year and dividends averaged 2%, you should want to feel confident that your fund returned about 10% to 15% ... rather than maybe +25% or maybe -10%.

Avoid stock funds that are "non-diversified", unless you are investing in a sector or specialty fund that concentrates on a specific sector (like gold stocks or real estate stocks). You want the lion's share of your stock money to be in DIVERSIFIED funds that invest in many different companies across the different industry sectors.

Avoid mutual funds with high yearly expenses and fees! Expenses are taken directly from fund assets, and work to lower investors' returns. A mutual fund with low expenses might return 10% in a given year. An identical fund charging over 2% a year for expenses would return closer to 8%. A bond fund with high expenses could return 4% in a given year instead of 5% due to high expenses and fees.

Finally, avoid mutual funds that have sales charges whenever possible. These sales charges are called LOADS. The most popular mutual funds that have sales loads are called Class "A" funds. Here's how they work.

You write out a check for $20,000 to invest in a stock fund with an up-front load (sales charge) of 5%. Right off the top $1000 goes to pay sales charges. Your investment is worth $19,000.

Once you really understand mutual funds and investing, you can save a lot of money by simply buying NO-LOAD funds on your own. Now you pay NO sales charges, and can invest with LOW expenses once you know the ropes.

After all, a penny saved is a penny earned.

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