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Top Three Mistakes With Mutual Funds

Since 1990, the number of U.S. households that own mutual funds has risen more than 75%. So, why are so many Americans turning to this method of investment?

Mutual funds offer cheap and easy access to stocks and bonds by combining the funds of many investors so that they may maximize the number of securities in which they can invest. This allows each individual to build a diverse and balanced portfolio, and avoid putting all of their eggs in one basket. It has become one of the easiest and most efficient ways for Americans to save money for long-term goals.

Sounds easy enough, right? Well, like every investment, there are tricks to the trade. Here are the top three mistakes of mutual funds:

#1 Focusing on last year's return and not looking at the costs

Focusing heavily on how much a fund made last year without taking into account how the funds performed over the last ten years could lead to trouble. And, remember, mutual funds typically have transaction fees and expenses. These costs add up and could eat up your potential returns — you need to consider how much a fund will cost over the amount of time you plan to own it. Before you purchase any investment, you should know the cost, risks, performance history and fees, as well as consider your age, risk tolerance and other factors. 

#2 Not having an honest strategy

"Beating the market" is not a strategy. Good strategies take into account how much risk you're willing to endure, what you will be using the money for, and how far out you need the money: Are you trying to buy a house? Working towards retirement? Or saving for your kid's college fund?

Keep in mind that mutual funds with a higher expected return likely have a higher risk of loss. Consider "target funds" that aim to peak in the year you need the money. However, because you probably have more than one goal, don't assume a target fund will be your one answer. You may also want to think about investments other than mutual funds. 

#3 Not tracking your mutual fund portfolio

Periodically review your investment portfolio. Look at the fund performance and the performance of the market. Review the fund's turnover to avoid paying excessive taxes. You need to understand the effect that taxes may have on the amount you end up with. Mutual funds that buy and sell stocks quickly have high turnover. While selling a stock that has moved up in price will yield a profit for the fund, that profit is taxed. Turnover in a fund creates taxable capital gains, which are paid by the fund's shareholders. Then make sure you look at your own circumstances — has anything changed? Do you need to make adjustments? 

Remember that past perfomrance is no indication of future earnings. Next year's loser could be this year's winner. 

You don't have to do it alone! A registered investment advisor or broker-dealer can assist you. Just be sure the individual you consult is licensed.

More from DFI: Mutual Fund ►


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