How to pick your first mutual fund
Posted
Mar 27 2009, 08:37 AM
by
Karen Datko
Rating:
This post comes from partner blog The Dough Roller.
Picking your first mutual fund is kind of like a first date -- scary at first, but later you wonder what all the fuss was about. And with the recent market volatility, investing in the stock market can be downright horrifying.
A couple years ago, a close relative spent some time with my family and me. We'll call her Susie (not her real name). Susie was 31, had one daughter (cute as can be), and had no retirement savings (not so cute). Her employer not only offered a 401(k), but also matched 100% of all contributions up to 6% of Susie's pay.
We got to talking about why she'd never starting saving for retirement, and her answer was illuminating -- she was intimidated.
Sure, there were times when money was tight, but one of the biggest hurdles for her was not knowing what to invest in. We spent about 30 minutes looking over her investment options, and I'm happy to report that she enrolled in her company's Fidelity 401(k) plan and began contributing 7% of her gross pay.
If you or somebody you know is in a situation similar to Susie's, this article is for you.
What's the biggest investing mistake you can make? As intimidating as picking your first mutual fund may be, the absolute biggest mistake you can make is not picking your first mutual fund. It's easy to put off retirement savings for another week, or another month, or another year while you think about your investing options. Susie's 401(k) had about 12 fund options, including stock and bond funds and a few lifestyle or fund-of-fund options (basically, a mutual fund that invests in other mutual funds rather than individual stocks). Picking any of those mutual funds would have been a better choice than not investing at all.
The point is, don't let fear or intimidation keep you from picking that first fund.
What should you look for in your first mutual fund? Assuming you have many, many years to retirement (which I hope, since this is your first mutual fund), at least two things will be important to consider in picking your first fund:
Two options
With these considerations in mind, here are two good choices I'd seriously consider today if I were starting out as a new investor:
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An S&P 500 index fund is a great place to start. This was Susie's choice. Her plan offered a Fidelity S&P 500
index fund that costs just five basis points per year (0.05%). Remember that 100 basis points is equal to 1%. In other words, for every $100 Susie invests in this fund, the fund will charge her account 5 cents per year. And the fund provides instant diversification, as it invests in the 500 largest U.S. public companies. One thing to note is that the amount invested in each of the 500 companies is based on the
market capitalization of the company, which I've written about before. What that means is that more will be invested in the larger companies in the fund than will be invested in the smaller companies.
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Single-fund solutions. An index fund is not the only option. Another choice Susie had was to invest in a fund that owns other mutual funds. Fidelity calls them Freedom Funds while Vanguard has a similar set of funds it calls Target Retirement Funds. These funds provide a mix of domestic and foreign stock funds and bond funds all rolled into one. The mix is based on how many years you have left until retirement. The upside is simplicity: One fund and you're done. The downside is lack of control. You're basically limited to a few options. Again, not a bad choice, just not what Susie wanted.
Other options
There are other options, of course. Susie could have chosen the Fidelity Magellan Fund (FMAGX). The fund was closed to new investors at the time, although the option was available to her through her company's 401(k). Magellan is an actively managed large cap fund that may have seen its best days years ago under the management of Peter Lynch. My first mutual fund was Legg Mason Value Trust (LMVTX), another actively managed stock fund run by Bill Miller. Picking an actively managed fund, I believe, requires a lot more research than choosing an index fund or single-fund solution. So I think Susie made a great choice for her first fund.
If you are a beginner, I highly recommend the book, "The Bogleheads' Guide to Investing." I bought Susie a copy, which she promised to read. Along with the Fidelity S&P 500 index fund, she was off to a great start. If you're just beginning or know somebody who is, let us know how you picked your first fund.
Related reading at The Dough Roller:
ALERT: Refinance your mortgage now!
'Debt Cures' by Kevin Trudeau -- Do his ‘secrets' really work?
Target retirement funds
