Mutual Fund  Basics

 

 The most accurate measure of  the performance of a mutual fund is its  total return. Total return is a yardstick that figures in factors such as dividends, capital gains or losses, and any decrease or increase in the fund’s share price.

Many people mistakenly believe that a fund’s yield is the best gauge.  Others think that the income the fund paid is the most useful barometer.  But there is one measure that is even more revealing; it’s called the fund’s “real return.” This calculation shows how the fund did after subtracting the inflation rate from its performance. The resulting number is a reflection solely of the actual growth of the fund; it gives you a number that is not “inflated.” Knowing how to evaluate your fund’s performance can help you make more money.

 

 Risk/Reward

 Suppose someone offered you two investment possibilities: Two companies issuing bonds at the same time with identical maturities, and one company’s bonds carry a much higher interest rate. Which would you think is the financially weaker of the two companies?

 If you guessed the one with the lower interest rate, guess again. The weaker company would be the one with the higher interest rate, because the higher the return, the higher the risk.  In the investment world, there are no free lunches.  So watch out for investments with high returns that seem too good to be true, and consider how much risk you are willing to take with your money in order to get those high returns.

 

Fundamental Investing Strategies

Do you know which type of investing historically has offered the best protection against inflation?  Many people would choose bonds or money-market funds over stock portfolios. But the facts show that in the past, stocks have had returns that average over seven percentage points above the rate of inflation, while bonds and money funds have averaged only two points over inflation. Those five percentage points would have made a tremendous difference over the years!

Investors are also unaware of the overriding importance of asset allocation. This refers to the way in which you divide your money among various investment options. The percentage you invest in stocks, bonds and money funds you assemble has a greater impact on long-term returns than your choice of individual funds.

 

On-going Costs and Fees

 What is your mutual fund’s expense ratio?  If you don't know, you should find out.  The expense ratio tells you average costs that you pay for fund management and maintenance expressed as a percentage of assets. In other words, it is an indicator of how much of the money your fund makes for you is actually spent on running the fund and how much ends up in your pocket.

The average fee for stock funds is about one-point-four percent.  Stay away from any fund charging a higher fee.

 Another cost investors don’t know about is called the 12b-1 fee, which is industry jargon for a marketing fee, or money spent to advertise the fund.  This fee simply drives up the cost of your fund and decreases your returns.  So look for a fund that does not charge a 12b-1.