How Mutual Funds Works
As you progress along the learning curve of how mutual funds work and become a more seasoned investor, or if you just have a bigger starting capital, you might be thinking of building a mutual fund portfolio. Building portfolio allows you diversify even further on your investment. A typical portfolio will consist of funds from different markets and of different asset classes. They will typically range from long-term to short-term, conservative to high-risk funds. There is no one fixed way to build a bulletproof portfolio and it really depends on the individual investor’s taste and investment goals/philosophy.
With that said, there are a few general guidelines which apply to all investors, let us explore them in greater detail.
The first thing you need to ensure is that the portfolio has to embody your investment goals and philosophy.
The next most important thing you have to do is to pick a few, 3 to 5 funds that represent the core of your portfolio. The core funds should form the bulk of your portfolio net worth. A good estimate would be between 60%-80%.
So what exactly does a core do? How does it help you?
A core is essentially the engine of your portfolio; they are funds, which you can count on to perform well every year even if the going is tough. These core funds will need to represent your key investment strategy. If your investment timeframe is on the short side, you might want to consider high quality short-term bond funds as the core. Similarly, if you are a long-term value investor, you might want to set the core as large cap value stock funds. A tip when building your portfolio is that you shouldn’t try to place more than 5 funds in your core group if you have limited resources. Focusing on slow, consistent gains, great managers and simple fund strategies will eliminate a lot of the distractions you face when you are evaluating the funds at year-end.
Outside the core, you want to include funds that are of higher risk, but have the potential to yield higher returns. This can include funds that are made up of high growth technology stocks or emerging market stocks. Because of the uncertainty involved, these small-cap funds also have higher potential of falling behind the benchmark. This is also why you want to take smaller position size in them. When your eggs are spread widely across a variety of baskets, you are less likely to collapse in a financial crisis.
We hope you have taken a lot in on how mutual funds work in this tutorial, and we are going to continue on to the top mistakes of mutual fund investors next.