Thursday, July 2, 2009

Mutual Funds: Rookie Mistakes

Beginning investors are often confronted by numerous descriptions of what mutual funds actually are. Some have even gone so far as to suggest that "A mutual fund is simply a firm that collects money from investors and invests them on stocks, bonds, and other money market instruments. If you invest in one, you will be considered a share holder and your portfolio will consist of a diverse investment."

This is a very simplified description of what mutual funds are. Consider this: a mutual fund is an investment whereby like-minded individuals (those who are looking for the same exposure to risk) hire a mutual fund manager who focuses on those investment goals and seeks to grow their money. Yes, they are shareholders. But unlike folks who buy individual stocks or bonds, they only own a portion of the investment with the group rather than owning a voting share.

You will also find that numerous financial planners and professionals also oversimplify the process by touting Fidelity or Vanguard, both of which are too big for their own good as the simplest way to enter this type of investment. This overlooks numerous other funds that do just as good a job, often at a lower entry fee and with better strategies.

Index funds, such as Vanguard's 500 can be less expensive fee-wise than most of its rivals but the $3,000 to get started will keep most beginners away.

Beginning investors (who are buying funds for their retirement, a tax-deferred situation that is best suited for actively managed funds and not for passively managed ones like indexes) should look to actively managed funds for low fees and expenses compared to their peer group, managers with tenure and low entrance fees. Index funds should be kept outside of tax-deferred plans due in part because they create no real taxable situation that would be worth putting off until the future - considering the capital gains tax for long-term investors is still low and worth paying as you go.

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