Deciding on an asset allocation can be a difficult decision, but once completed, selecting appropriate mutual funds to fulfill the chosen asset allocation can be ridiculously easy.
Explore This IssueACEP Now: Vol 33 – No 07 – July 2014
Mutual funds sold by mutual fund salespeople masquerading as financial advisors also have loads, or commissions. These range from 3–8 percent of your investment. Some are front-end loads (A shares), paid when the money is initially invested. If you invest $1,000 in a mutual fund with a 5 percent front load, $950 goes into the mutual fund and $50 goes into the pocket of your advisor. There are also back-end loads (B shares), where the commission comes out when you sell the investment, and C shares, where the load is ongoing in the form of a higher expense ratio. However, because the best mutual funds have no load at all, there is really no reason to ever buy a loaded mutual fund. If you need investment assistance, pay a fee-only advisor for advice to minimize conflicts of interest. Be aware that most 401(k)s not only charge additional fees, they are often filled with loaded, high expense ratio, actively managed mutual funds. Do your best to avoid the most expensive options when selecting 401(k) funds. Remember that the very best predictor of future mutual fund performance is low fees.
Step 5: Avoid Performance Chasing
Academic studies have demonstrated time and time again that there is no persistence in performance among active mutual fund managers. Actually, that is not entirely true as the worst managers do persist in being terrible. Investors are notorious for buying high and selling low, dramatically underperforming the funds they are invested in due to their terrible timing. The solution is to avoid timing the market at all. Rather than choosing a fund (or an asset class) based on its past performance, simply follow your written investing plan. If your plan says 30 percent of the portfolio should be invested in U.S. stocks and due to recent market changes your portfolio is only 25 percent U.S. stocks, then buy some more to rebalance the portfolio. This forces you to buy low and sell high.
Following these five steps when choosing a mutual fund will help you reach your retirement and other investing goals.
Dr. Dahle is the author of The White Coat Investor: A Doctor’s Guide to Personal Finance and Investing and blogs at http://whitecoatinvestor.com. He is not a licensed financial advisor, accountant, or attorney and recommends you consult with your own advisors prior to acting on any information you read here.