Mutual Fund Investing

The entry level to investing is with Mutual Funds, so that’s where you should get started. For that reason, and the fact that most 401K savings are held in these funds, we focus our newsletter topics in this area. The Mutual Funds that we write about meet the following criteria:

1. No-Load Mutual Funds (Although some may have Redemption fees for short-term trading)
2. Available at many brokerages without a transaction fee
3. Open to New Investors
4. Minimum Investment is No More than $5,000

The best way to get started in the market is with Dollar Cost Averaging. You do this by investing a fixed amount at equal time intervals, usually on a monthly or quarterly basis. This allows you to move into the market over time, reducing your risk of untimely market entry. The result is that you purchase more shares of a stock or mutual fund when prices are relatively low and less share are purchased when prices are relatively high. This can result in lower average per share cost over time. Most mutual funds and 401k plans offer automatic investment and exchange programs that can make this simple to implement.

Many 401K plans have a limited number of funds for you to choose for your portfolio, but don’t let that stop you from diversifying. You will normally see at least one choice in the Mid Cap and Small Cap categories from the Big Three so you can do this. Sometimes you will find that other suggested funds have performed considerably better than those in your fund family, so if your plan or brokerage account allows it by all means consider adding one of those funds to your collection.

While we’re talking 401K plans, don’t invest your 401K plan money in your company stock, unless the company match is in company stock, in which case that’s the only choice you have. Since your paycheck is tied to the success of your company, you shouldn’t tie your future retirement to the success of the company as well. The old saying “Don’t keep all your eggs in one basket!” applies to your 401K, so diversify your portfolio with more than one asset class.


A simplified approach to diversification is to pick a Large Cap Value Fund and a Small Cap Blend Fund to combine with your Short-Term Bond Fund and leave it at that. While this approach may be useful if you only want to check your portfolio on an annual basis, it’s not something we’d suggest for our readers. Then of course you have the other extreme. Pick one fund from each of the nine stock fund categories, a couple of bond funds, a real estate fund, an international fund, a technology fund, and don’t forget to double up on your small cap growth and value choices. That would make 16 funds for you to keep track of. Not exactly the best way to simplify your life, but if you have a large enough portfolio, it’s actually not bad idea. For most people however, we’d suggest something in between.

Bond Funds

There’s not a lot of difference in the performance of Short-Term Bond Funds from one family to another, so for ease in moving your money between investments, we’d suggest that you just use the one offered by your fund family or brokerage. In fact, unless you want to watch the bond market closely, we’d recommend doing this with all of your bond fund choices.

Investors reaching for higher yields will probably not be satisfied with Short-Term Bond Funds, but these funds act somewhat like a safe haven when interest rates start to rise. If you need additional income, Intermediate Bonds are our choice when the economy is weak and interest rates are falling, while High-Yield Bonds are best with the rising interest rates that go along with a strong economy. When you invest some of your money in Intermediate Term Bond Funds you should consider moving it to Short Term Bond Funds when interest rates start to rise for a couple of reasons. The value of the Intermediate Term Bond Funds will fall faster than Short Term Bond Funds, and the yield on the Short Term Bond Funds will rise faster than Intermediate Term Bond Funds.

Real Estate Funds

Another way to obtain good yields is through Real Estate Mutual Funds. While these funds have performed considerably better than bond funds over the last 25 years, they are also a lot more volatile. That being the case, this is an asset class to pay attention to, because there are good times and bad times to be invested here. When you are invested we suggest you don’t invest more than 10% of your portfolio in these funds.

Stock Mutual Funds

Stock Mutual Funds are often categorized by size (market capitalization) and style (growth vs. value).

Most funds are categorized as Large, Mid, or Small Cap; depending on the size of companies they focus on. Growth investing is a style that selects stocks of companies with rapid earnings and revenue growth that is expected to continue in the future. Value is an investment style that selects stocks of companies that are priced below their estimated value. A company exhibiting good value is generally taken to mean that its assets are selling for less than their intrinsic value, and such companies tend to have low price-to-earnings ratios.

Large Cap Funds that blend the growth and value styles come fairly close to replicating the S & P 500 Index, so most of them perform similarly. Since large companies don’t grow as fast as small companies, so if you’ve only got room for one Large Cap Fund in your portfolio, we’d suggest a choice from the Large Cap Value category. The recent reduction of the tax rate on stock dividends makes this choice even more sensible in taxable accounts since these funds are the highest yielding funds that qualify for this tax cut.

Since Fidelity, and Vanguard are the largest fund families that sell directly to investors, it’s not surprising that they perform best in the Large Cap arena. We usually have no problem finding funds from each of these companies that performed better than average with reasonable risk in all three Large Cap categories. If those funds aren’t available to you, we will always have two or three additional choices.

We believe that money managers have a better opportunity to add value to a portfolio of small company stocks than they do with large company stocks. This is one area of the stock market where we feel actively managed Mutual Funds have an advantage over passive Index Funds. Of course you must remember that while there’s a better chance for these funds to outperform the market, there’s also a greater chance for these funds to under perform the market as well, so choosing a fund with a proven manager is very important when choosing small company funds.

Technology Funds

Technology Funds are the most volatile category of Mutual Funds, so we recommend you don’t put more than 10% of your portfolio in Tech funds. Given the explosive nature of these funds, you must pay close attention to them. The Insightful Investing Newsletter is a good way for you to do that. Most of us learned the hard way, during the Internet bubble, that its best to take some profits, and cut your losses short, especially in this sector. Would you rather have paid a 35% tax on your 100% profits in 2000, or given up in 2002 with a 50% loss?

International Funds

Although the global economy has linked the stock markets of the world, there are still good investment opportunities outside of the United States. Since some managers have done considerably better than the averages in this category, we still think there’s room in your portfolio for these funds.