If you've decided that managing a portfolio of your own stocks is too time consuming, then mutual funds are the perfect opportunity to invest with less hands on responsibility. However there are points to consider when deciding which fund youâ€™ll buy.
Broadly speaking mutual funds can be categorized into actively managed and passively managed funds. In the first category, funds are managed by professionals who try to follow a general philosophy of investing. They may ascribe to investing styles all the way from high risk, high reward stocks to the other end of the spectrum which includes conservative picks that will likely provide slower, but steady growth.
First time investors, or those wracking their brains after losses with actively managed mutual funds should also take note, various index funds are low cost and have historically provided steady returns which have often beat actively managed funds in the long term.
Passively managed funds include what are called index funds. Index funds require much less maintenance since they mimic, or try to copy the performance of the companies listed on the index as it takes its ups and downs. Investors bet that the market will rise in the long run, despite some momentary set backs.
There's something to be said about expenses when talking about index funds as well. Mainly, buying index funds from a brokerage usually comes with much lower fees than actively managed funds.
Actively managed funds have the expert guidance of a fund manager, along with his or her cavalcade of analysts. Those people don't work for free. With the greater possibility for quick profits, there's also the cost of paying them for their services. It could pay off. A quick footed or prescient manager can avoid losses by selling off certain undesirable stocks in a fund before the damage is done.
However this isn't always the case. In comparing the performance of actively managed funds to those which are passively managed, it pays to know a bit of the philosophy and history behind them.
The philosophy behind the index fund is that the market will eventually go up. The investor in an index fund will generally have an optimistic view, with tolerance for unexpected losses. Long term perseverance is needed, but it is possible because of the belief that the market will inexorably continue its steady pace upward over the years.
The premise behind mutual funds is that a diversified portfolio of stocks brings an added stability to your investment. If one company's stock suddenly plummets you are protected from serious losses by more stable stocks in the fund. Index funds, especially one of the most historically profitable ones, have this diversified characteristic.
The idea for creating an index fund was simple but not popular at first. In 1976, the founder of the Vanguard Group, John Bogle, proposed that a mutual fund be created that would passively track, or mimic the Standard & Poor's 500 index, a mix of 500 of the largest U.S. companies. The performance of the companies listed on the S&P 500 index would tell the investor what performance he or she would see. With the average fund manager always looking to beat the market, investing in something that would just mirror the market may not have seemed aggressive enough and even foolish.
Yet, the S&P 500 has done well since that time. The Vanguard 500, which is the name of the index fund that Bogle started in 1976, has delivered an average annual return of 12.23 percent since its inception.
That success story has been imitated by other brokerages. Many now offer the same 500 stocks through their own mutual fund under a different name of course. Popular offerings include Fidelity's Spartan 500 which got its start in 1990.
Index funds are a good place to start. However you should be aware that such an investment is made for the long term, and thereâ€™s no guarantee that the market will continue to rise, except the belief that the economy will continue to improve. There may be sharp downward turns from time to time, as the bursting tech bubble proved in the early part of this decade.
Another thing to keep in mind is that index funds are by no means the only investment you should have but thereâ€™s something to be said for a category of mutual funds that has generally proven to be a winner.