If you are a beginning investor, mutual funds offer a really attractive option; they allow you to build an investment portfolio even if you don’t have the time, experience or inclination to manage your own investments. But, in order to be truly successful with mutual funds, avoid these five common mistakes investors make.
Relying on Past Performance
It may be tempting to look at how the fund has done previously, and use that as an indicator of how it could do in the future. But relying on past performance is one of the most common mistakes investors make. While this can be a winning strategy in many instances, past performance does not always equal future success. Consider this: People who invested in cassette tape manufacturers in the 80s may have enjoyed big gains throughout the decade, but technology has advanced and cassettes are no longer in production. Investors looking only at past performance would be disappointed today. A better approach would be to have a basic understanding of the industry you are investing in, and emerging technology and innovation in the field.
Putting All Your Eggs in One Basket
When looking at potential funds, diversity is the name of the game. You want to choose multiple funds that each have a different focus. Advisors will often suggest funds in different industries (like real estate, energy, manufacturing, etc.) so that if one area struggles, your overall portfolio won’t take a hit. The more diverse your portfolio is, the less the losses from one sector or another will affect your overall fund performance.
Not Understanding the Investments
If you own one mutual fund, you may rely on the fund manager to diversify the investments. But this strategy only works if you invest in one mutual fund; if you invest in multiple mutual fund accounts, your investments may overlap. In other words, your investment portfolio has a greater likelihood of becoming unbalanced (or too heavy in one area and too light in another) if you invest in multiple mutual funds without understanding the focus of each fund. Avoid this common investing mistake by making sure you understand how to prevent this overlap.
Not Understanding Fee Structures
When it comes to mutual funds, you will pay different fees based on the fund you go with. If your mutual fund is actively managed, you will pay more in fees than passively managed funds. Indexed mutual funds generally carry lower fees, but may produce at a slower rate. Depending on how the fund is structured, you may avoid paying fees until you sell the fund.
Not Understanding the Tax Structure
Your mutual fund may be a part of a corporate retirement plan, like a 401(k), or it may be part of an outside retirement investment account. The tax structure on these mutual fund accounts is very different. (One invests with pre-tax income, and you will be taxed upon the sale of the fund; the other can be done with post-income tax, or income you have already been taxed on, so it carries a different tax implication.) Your financial professional can help you understand the nuances of each situation and help you ensure that you avoid “taxing” situations.
Mutual funds can be a great way to diversify your investment portfolio, if you can avoid these common pitfalls. Luckily, your Farm Bureau advisor is here to help — they can answer your fund questions and help you navigate investing in mutual funds.