If you decide to invest in an actively-managed fund, see how it compares to its benchmark. For example, the Russell 1000 Growth Index is the benchmark for many growth funds. The Russell 1000 is the collective performance of 1,000 growth stocks.
You might see mutual funds advertise their Morningstar Rating. Morningstar is an investment research firm that provides ratings of mutual funds. Each fund with at least a three-year history receives a rating from a high of five stars to a low of one star. The top 10 percent of funds in a particular category receive five stars. Lipper is another company that rates mutual funds.
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| Common Mistake: Buying High Performers |
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New investors sometimes make the mistake of chasing the hot mutual fund that performed well last year and that’s no guarantee of success. Sometimes, the top-performing mutual funds attract too many investment dollars and that makes it difficult for the portfolio manager to duplicate last year’s success. While past performance is not indicative of how your fund will do in the future, it is still a way to evaluate the volatility of a mutual fund.
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| Tip: Remember Your Preferences |
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Even though mutual funds offer you more diversification than individual stocks, bonds, or other investments, economic conditions and other factors may send them spiraling downward. Make sure you fully understand the risks you’re taking with your money. The mutual fund you invest in should be consistent with your investment goals, time horizon, and risk tolerance.
To diversify your nest egg, invest in a variety of funds that use different investment strategies. Although you may not achieve the highest rate of return, you’ll couch your bets among mutual funds that will achieve different levels of success. Diversity reduces the volatility of your investments.
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