With more than five thousand mutual funds available, how do I choose?
You can buy mutual funds that invest in almost anything you want. Once you decide on your goals, you now have two other choices: Do you buy a managed mutual fund, or do you buy an index fund?
MANAGED FUNDS
A managed fund is run by a manager who decides what he or she is going to buy and sell with all the money the investors have deposited into the fund. If you know what kinds of things you’d like to invest in, you find a like-minded manager and choose that fund, if its track record stands up to scrutiny. When you buy a managed fund, you’re actually investing in the manager who’s in charge of the fund. A good manager buys and sells wisely, so that the NAV or the value of your shares goes up and you make a profit. A mediocre manager could lose you money. Thus it’s important to keep track not only of how your fund is going, but also of the manager who’s responsible for your return.
Rule of thumb: Before you ever buy a managed mutual fund, look to see how long the manager has been in charge. Is the current manager the one responsible for a fund’s terrific track record, or has that person moved on, leaving someone new in charge? It’s the manager’s track record you want to know about, in other words, not the fund’s, because the manager is the one who creates the fund’s success.
A number of publications monitor the funds—how they’re doing, who is moving on—but the one I like best is called Morningstar. You can subscribe to it directly, find it at the library, or access it on the Web or in the Personal Finance section of America Online.
INDEX FUNDS
When you don’t know which mutual fund to buy, and don’t want to learn all this stuff about managers, you have a great Option: You can buy an index fund.
There are several indexes that track the values in the stock market. You hear abqut these every day when you listen to the news and constantly hear the newscasters quoting the Dow Jones Industrial Average. You know how they’ll say, for instance, “The Dow Jones is up twenty-three points today and closed at 5600.” The Dow Jones average is an index based on thirty stocks. If these thirty stocks happen to go up, so does the Dow Jones average, and if they go down, same thing. I always found it fascinating that so much seems to rest on just thirty stocks, but it’s used widely.
To my mind, a far better index, and one that’s also widely referred to, is the Standard & Poor’s index, the S&P 500. This index tracks five hundred stocks, which is a lot more than thirty, of good-size companies that are traded on the New York Stock Exchange. You will often hear this index quoted right alongside the Dow Jones, and when you do, pay attention. This is also a great index because so many people use it to measure the market—which means that many, many experts are keeping tabs on it every single day.
There are other indexes that track the American and overseas stock markets (as well as indexes that track the bond market, but we are focusing on stocks here); they aren’t quoted as much as the Dow Jones or S&P, but they’re also used to track hOW everything is doing overall. Among them:
The Wilshire 5000 equity index. This index tracks thousands of stocks of companies of all different sizes, large and small. It’s also outgrown its name—it really follows almost Neven thousand stocks. Even though it’s not widely quoted, it’s one of the best.
The Russell 2000 index. This index tracks two thousand stocks that are traded on the OTC (over-the-counter) market.
H The EAFE index. This one ranks the stocks in Europe, Australia, and the Far East.
Mutual funds constantly compare their performance tothat of the various indexes. A fund will boast of “outperforming the S&P 500” over a cçrtain period of time, meaning it increased in value by a greater percentage than did the S&P index. (Of course, many funds underperform the indexes, too.) So one easy and effective way to invest is to buy what’s called an index fund, which simply buys all the stocks in the index you’re interested in. Its performance will, by definition, match that of the index exactly, whether it’s the S&P 500, the Dow Jones, or the EAFE. Many mutual fund companies offer S&P index7 funds, as well as growth, international, and bond indexes, and it’s easy as can be to sign up with one of them.
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