Before you choose a mutual fund (or make investment decisions in general), make sure you understand how it fits into your overall investment strategy. Here are a few things to consider.
Know your goals
This is the fun part. Sit back, close your eyes and imagine your retirement dream. Then think about other goals, such as funding a child’s education or buying a new home. Once you’ve established your goals, you can create a plan for how to reach them.
Consider your risk tolerance
Are you a conservative, moderate or aggressive investor? Your risk tolerance reflects how you choose to balance fund volatility with the potential for greater growth.
A higher degree of risk can potentially achieve a higher rate of return. Less-risky investments may have less potential for growth. You have to find the right balance that helps you work toward your financial goals and still allows you to sleep at night.
Evaluate your time horizon
How much time do you have between when you invest and when you need the money? Time is an important factor in your investment strategy.
If you are able to hold your investments for a longer term, you may be able to tolerate more risk because your investment has more time to take advantage of potential market gains and more time to recover if the market goes down. If your time horizon is short, you may have less risk tolerance because you have a shorter time to recover from any potential losses.
In addition, if you have a longer time horizon, you can select an investment that offers tax-deferred growth until you withdraw the money. Not only does your investment have a chance to grow, but so does the money you would have paid in taxes along the way.
Learn about the strategy – and the costs – associated with a fund
Some mutual funds invest in a particular market or follow a particular investment strategy. Some invest in large companies with a history of low but consistent returns, while others invest in small, fast-growing companies.
Before you invest, carefully read a fund's summary prospectus and/or prospectus, along with other brochures and information from the fund company’s website. Then ask your investment professional to help you evaluate how a fund fits with your investment goals.
And be sure to find out what costs (fees and expenses) may be charged for a fund, such as sales charges and gross expenses.