Matching Mutual Funds To Your Investing Needs

By Christopher w Smith. 

Mutual funds are an excellent investment vehicle for medium and long term investment strategies, but there's a bewildering array of them, ratings of them, derivatives based on them, and a highly complicated jargon involved. Even more telling, the people you're most likely to talk to about them (your investment broker) are people who get paid commissions to recommend funds to you. While we're not going to impugn an investment broker's motives (after all, he wants repeat business to keep earning those commissions) there are some questions and statements you need to make to ensure that the mutual funds you buy meet the aims you need. Its called Mutual Fund Suitability Compliance - matching mutual funds to your investing needs. 

The first should be pro forma - you and your investment adviser should talk about your investment goals, whether they're wealth preservation, revenue generation, or managed growth. Wealth preservation is buying funds loaded in stocks that are comparatively non-volatile; examples are Proctor and Gamble, or Archer Midlands. These are stocks that will increase over time (generally beating inflation by a few points). 

A growth-oriented fund is one that picks stocks with the potential for significant increases in the value of the stock over time. Examples of stocks in this sector would be Google or other new businesses just starting out, or businesses that have otherwise created a new market. Revenue generation funds are bond funds (or just buying bonds), or money market funds - these give a regular payout every month, but don't have the best return rate.

What differentiates these three types of investment is the degree of risk undertaken by the investor. In general, the higher the risk, the greater the return - bonds and money market accounts are very low risk, but very low return. Growth funds have higher risks (but still less than picking individual stocks), while wealth preservation funds are useful for keeping a balance.

As you mature, your mix of funds in an investment portfolio should change. In your 20s and 30s, you're almost always better off with a mix of growth funds and wealth preservation funds, with a modest amount of bond funds. The reasoning behind this is that your retirement is a good forty years away, and for the last 130 years, over a decade long period, the stock market has outperformed bonds and money market and savings accounts 85% of the time - and over 96% of the time when compared over a twenty year span. So, with a long time horizon, a growth fund gives you the maximum return on investment; as your earning potential increases with time (due to promotions and upgrading your career), this will also insulate you from market volatility.

Your money market account is your "oops" account - use it to cover emergency expenses, or to accumulate funds for your house.

As you hit your 40s, and start hitting your maximum earning potential, the mix of funds should shift from growth-oriented funds to wealth preservation funds, while slightly increasing the holdings socked away in money market and bond funds.

As retirement nears, the ratio should shift again - more from wealth preservation to bonds to generate a regular income stream without crippling your growth rate. You'll still want some growth funds in there to make sure that your wealth will remain there through the rest of your retirement.

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