Risk involving changes in the market

Even with expert management, however, the risk involved in mutual fund investing does not disappear. Sometimes, the stock or bond market as a whole may be in decline, and even smart investors are unable to make a profit. Such hard times are referred to as bear markets.
The opposite of a bear market is a time when the markets are steadily rising — bull market. Pessimistic investors are sometimes referred to as bears, while optimists are bulls. Now you understand the livestock references that you often hear scattered throughout financial news reports!
If you’re a long-term investor, bear markets may not be a problem. You can probably wait until the market rebounds before selling your shares. A short-term investor, however, may get stuck with losses. Although you can’t avoid risk altogether, you can choose money market mutual funds or other investments that don’t tend to fluctuate dramatically.

Risks involving fund management

These days, mutual funds are among your safer investment options. Diversification, professional management, and the fraud-prevention exercised by the Security Exchange Commission and other regulatory bodies all help ensure that mutual funds stay relatively safe. Nonetheless, investing in mutual funds carries various kinds of risk that can impact your financial planning.

One risk that’s inherent in the nature of mutual funds is the fact that you, the investor, have no control over what’s being purchased for the portfolio. You are putting your money —and your investment fate — in the hands of the fund manager, which is why you need to study the track record of the fund company and the individual manager before you invest. Making sure that you’re giving your money to a reliable partner is important to your pocketbook and your peace of mind.

Another unpredictable challenge may arise when a fund’s “star” manager retires or changes jobs, leaving the fund without his expertise or brilliance. For example, Peter Lynch was one of the most successful and famous mutual fund managers in the world for many years. Under his guidance, the Fidelity Magellan Fund grew into the largest mutual fund anywhere, with over $72 billion in assets. Millions of investors poured money into Magellan, attracted largely by Lynch’s reputation and prestige. Since Lynch’s retirement in 1990, however, Magellan has performed with far less success, despite the strong performance of the stock market overall. If you’re a fund investor, follow the financial news. Be aware when changes in the management of your funds occur. You may want to consider switching funds when the manager responsible for your fund’s track record departs the scene.

Shareholder services of Mutual Funds

Many mutual fund companies offer a range of useful, sometimes valuable services to their customers. These may include

• Check-writing privileges
• Ability to invest, withdraw, or move money via mail, telephone, or the Internet
• Automatic investment via payroll deduction
• Record-keeping for filing your income tax return
• Access to research reports about companies, funds, and economic trends

A fund’s prospectus tells you more about such services.

Liquidity of Mutual Funds

Liquidity refers to the ease with which you can buy or sell an investment. Buying or selling a particular stock or bond, especially one held by relatively few people, may be difficult. If you need cash in an emergency, this obstacle to turning your investment into legal tender can cause inconvenience and may cost you money. By contrast, mutual fund shares can be cashed in quickly at any time by redeeming them with the managing company, usually at little or no cost.

Professional management of Mutual Funds

Mutual funds hire smart investment experts to manage your money, and they have access to extensive research into companies, economic conditions, and market trends. Most people would have a hard time keeping track of a large number of investments in many different businesses; staying on top of that financial activity is part of the daily routine for the research staff of a mutual fund.

Low cost entry of mutual funds

You can get started in mutual fund investing with relatively little money — a benefit when finances are tight, but you’re mentally ready to roll with an investment experience. When you buy shares of an individual stock, any purchase less than 100 shares is usually considered an odd lot, on which you must pay a high sales commission. But a bundle of 100 shares of stock isn’t easy for most investors to afford. If a stock is trading at (for example) $75 per share, 100 shares will cost $7,500 — a significant amount of money for most people.

By contrast, you can start investing in most mutual funds for just $1,000 to $2,000, and add to your investment later with even smaller amounts by sending a check to the fund company or arranging for automatic deductions from your checking account.) If you have only a small amount of money to invest but are eager to get started in mutual funds. This list, which is based on information provided by The Mutual Fund Education Alliance, gives you a sampling of fund companies and categories to consider when you’re looking to invest $500 or less. You can request information on specific funds by contacting any broker, the fund companies themselves, or The Mutual Fund Education Alliance (www.mfea.com).

Diversification of Mutual Funds

Diversification involves spreading your money around among several different kinds of investments in order to reduce the risk of concentrating in a single security. When your investments are diversified, you don’t take a major hit if any one investment performs poorly. Thus, the savvy investor avoids concentrating all her investments in the stock of a single company, or even a single industry. You may be lucky enough to work for a company that helps you invest through a 401(k) retirement plan or by awarding you stock options — the opportunity to buy the company’s stock at a special, often discounted, price. Either way, you enjoy a great reward for being an employee. But be careful — employees sometimes end up investing almost their entire savings in the stock of the company they work for. All is well as long as the company is flourishing. But if the industry suffers a downturn, or if your own company happens to go bankrupt, you may find that your investment is suddenly worth little or nothing.

Mutual funds also allow you to diversify your investments at a relatively low cost. Because of transaction costs (the fees charged when you buy or sell stock), you can waste time and Volatile investment Volatile investment money buying one or two shares of stock in a dozen different companies, which may be all that an investor with a couple of thousand dollars can afford. But the same investor can easily afford to invest in one or more mutual funds. Buying mutual fund shares makes you a part owner of many different types of stocks (or bonds), giving you the benefits of diversification at a fraction of the cost. By definition, any mutual fund offers some degree of diversification, because every fund invests in many different stocks or bonds. But some funds are more diversified than others. For example, sector funds, which concentrate on investing in a single industry, are less diversified than most other stock funds. When economic trends favor that industry, the corresponding sector fund profits.

For example, during the late 1990s, sector funds that concentrate on the stock of Internet companies and other hi-tech businesses have done very well. If and when high-tech industry flounders, however, the technology funds will, too. Thus, keeping all your money is one such fund would be a risky strategy.