Friday, May 3, 2013

Mutual Funds Allocation Strategy


If you have money that you want to invest, consider mutual funds as an alternative to individual stocks, which tend to be more volatile than investing in a mutual fund. But, before you simply select a mutual fund for investment, you need a strategy and a means to allocate your money. There are three important considerations for your allocation strategy.

Lack of a Strategy
Mutual funds are collections of investments that are organized together. They collectively invest in a variety of stocks, bonds and money markets. According to Jack Piazza of Sensible Investment Strategies, the first error that most people make when investing in mutual funds is that they literally do not have a strategy. You must always have an asset allocation strategy that defines your investment objectives, risk aversion and time limits for each mutual fund investment. These are three crucial factors for an allocation strategy. If you do not consider these three factors, then you will invest haphazardly in mutual funds, failing to yield the monetary benefits that you desire.

Investigate the Fund
To adequately address your investment objectives and risk aversion, you need to understand the mutual fund itself. According to the SEC, be wary of the mutual funds fees and expenses. If your fund has high fees it should be high performing. High-performing funds tend to have higher risks and may not be a suitable investment for you. Additionally, knowing how the fund affects your taxes is also an important part of your allocation strategy. Be sure you understand how a sale of a mutual fund affects your capital gains. Know the age and size of the fund. Funds that invest in smaller companies are called small-cap funds, and funds that invest in larger companies are called large-cap funds. Larger funds tend to be more stable.

Failing to Diversify
Another error in the allocation strategy is placing large amounts of your investment portfolio in higher-risk mutual funds. To many investors, the focus is on the higher reward these mutual funds can yield, but the high reward comes with higher risk. Always diversify your portfolio with lower-risk, lower-reward funds and medium-risk, medium-reward funds along with high-risk, high-reward mutual funds. Diversified funds have a mixture of investments in both high- and low-risk stocks as well as bonds, which are debt investments with large institutions or corporations. Bonds function as loans that the institution takes, and it pays you interest on the loan amount. According to Piazza, investing 5 to 30 percent of your portfolio in high-risk mutual funds is reasonable.

Duplicate Mutual Funds
There are a variety of mutual funds in which you can invest. Be sure to consult your allocation strategy objectives before investing in a specific mutual fund. If you fail to do so, you may be investing in mutual funds that are serving identical objectives in your allocation strategy. For instance, you could have two mutual funds that focus on small growth over long time periods. According to Piazza, the duplication lessens the diversification that investing in mutual funds provides.