3 Key Factors to Consider When Choosing the Best Mutual Funds

3 Key Factors to Consider When Choosing the Best Mutual Funds

As you invest for retirement, you’ll face a number of different options. One of the most popular investment options is the mutual fund. Investing in a mutual fund allows you to diversify your portfolio, at least in part, and thus lowers risk while maintaining impressive returns. While mutual funds aren’t the only part of a holistic investment plan for retirement, most people will have shares in at least one.

However, it is important to recognize that thousands of mutual funds exist, and they all have different goals and purposes. Finding the right one for your individual needs may seem daunting at first, but thinking about a few key points like your timeline, risk tolerance, and investing expectations can help narrow the choices.

Considering Your Retirement Timeline When Choosing Mutual Funds

An important point to remember when it comes to retirement timeline is the fact that many of the larger companies have funds designed for retirement at a specified end date. Target-date retirement funds have a mix of stocks and bonds in an allocation that starts out aggressive and gets more conservative as the retirement date draws near. This automation allows you to avoid having to make manual adjustments while ensuring that your risk tolerance is appropriate for the time you have to invest. Many people like target-date funds because they take much of the guesswork out of risk tolerance and do not require frequent rebalancing.

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Your timeline has a significant bearing on how you should invest. People who have many years left before retirement tend to focus on capital appreciation and have a higher risk tolerance, because their portfolio will have time to bounce back after a downturn. Growth funds are often a good choice for people in this situation. People who are closer to retirement will likely focus more on securing their income with lower-risk options. Income funds serve these needs nicely because they are less impacted by financial downturns and can continue to deliver income.

While these are just generalizations, they can help guide your initial thoughts on the type of fund that makes the most sense for your given situation.

Determining the Primary Investment Goals of a Mutual Fund

As mentioned above, the two primary types of mutual funds are growth and income funds, and the choice between the two often depends on how far you are from retirement. However, personal preference also comes into play because some people may want to be more conservative from the beginning, while others may feel more comfortable with risk even when their retirement is just around the corner.  Understanding the goals of these types of funds, as well as the range of funds under each category, can help you make the right choice for your needs.

Growth funds are primarily designed to grow your principal, and they accomplish this with stock investments in companies that are likely to perform above the market average. Income funds focus on stocks and bonds that pay dividends. Generally, they prioritize the preservation of assets, income, and growth, in that order.

The important thing to understand about these two types of funds is that people should have a balance of both rather than relying solely on one or the other. While most people will focus on growth funds when they are younger and income funds when they are closer to retirement, the best ratio will differ for each investor. Holding both types of funds actually has some significant benefits in terms of diversification, since they will invest in different types of assets.

Choosing Mutual Funds Based on Personal Risk Tolerance

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As alluded to already, risk tolerance is another important consideration when selecting the best mutual funds for you. Some people prefer to sacrifice growth for a lower level of risk while others are comfortable with higher risk to maximize returns. People with a high risk tolerance tend to gravitate toward growth funds since they have the greatest potential for returns, but keep in mind that risk levels vary even within this class of mutual funds. Aggressive growth funds invest in riskier assets, and conservative growth funds focus on securities that are less likely to fall in value. There’s a continuum of risk within the broader category, and you need to decide where you fall on it.  

Likewise, income funds are generally less risky because they focus on generating reliable income, but they also may have varying risk levels. Conservative income funds will focus solely on assets that generate income. However, you can also choose more aggressive income funds that try to couple capital appreciation with cash payments.

Your risk tolerance is a personal consideration that you’ll probably evaluate again and again over time. Ultimately, your timeline, goals, and risk tolerance should all be considered when it comes to choosing the right mutual funds for your portfolio. All three are important.