You started a new job and as soon as arrive at the new user orientation they hand you a nice looking packet with a middle aged couple standing in a pasture gazing at each other. Under the tear jerking picture is some inspirational phrase like, “Take charge of your future”. You know what it is and you know what you’re going to see when you open it up. It’s going to be a bunch of booklets that don’t have a happy couple in a pasture. It’s a brochure full of tiny yet really big words and your chances of understanding those words is marginal at best.
Still, you have to pick mutual funds that will take on the job of making you enough money to retire and maybe someday have your picture on front of the packet. How do you pick the right mutual funds for the job?
From your perspective, the good news is that your employer’s plan only gives you the option of certain funds and although money managers might not see that as a positive, it helps to limit your choices. How do you pick the right funds? Here’s a few tips to help you know how to pick a mutual fund.
Your Risk Tolerance
Are you the bungee jumping off a bridge type or is your idea of wild and crazy trying a new restaurant? However you answer that question gives you an idea of your risk tolerance. With less risk comes less reward but a basic way to look at risk other than only looking at your personality is to think of your age. The younger you are, the more risk you can handle, especially when you invest for retirement. The reason for that? If the world goes in to economic meltdown, you have plenty of years to recover.
Those funds are easy to spot. They use words like “aggressive” and “growth”. There’s no question what they’re designed to do. If you’re further along in your career, pick funds that are more conservative. If they don’t have a summary with a graph showing how conservative or aggressive, go to the Morningstar website and read more.
Cap it Off Right
“Cap” is short for capitalization and capitalization is simply how much money a company has. Large or mega cap companies are companies like General Electric, Barclays, and Apple. Large cap companies are safe but they don’t have the growth potential of the small cap companies. Aggressive funds often have a lot of small cap companies with the more conservative funds having the larger caps.
An index fund tracks a certain collection of investments. Every popular index in the world has an index fund which is a mutual fund that moves in tandem with a certain index such as the Standard and Poors 500 index. These tend to be aggressive in nature so have more of these in your portfolio when you’re younger.
You don’t want your asset allocation to be 100% aggressive, 100% conservative or 100% anything. Strike a good balance between aggressive and conservative, large cap and small cap, index funds, and bond funds.
Now that you know how to pick a mutual fund, don’t forget about the funds you picked. Watch them closely and if over the course of a few years they aren’t working well, replace them with something else. No need to make a lot of frequent changes. Give them time to work but don’t be afraid to make a change when you no longer feel comfortable with your portfolio.
Tom Drake writes for Financial Highway and MapleMoney. Whenever he’s not working on his online endeavors, he’s either doing his “real job” as a financial analyst or spending time with his two boys.