Mutual funds let you diversify your investment within the same account. Instead of keeping several accounts open with different financial institutions, you tell the fund’s manager how you want the principal money distributed among stocks, bonds and money market funds. A balanced cash distribution within a mutual fund is different for every investor. It should reflect your final investment goal and how much financial risk you feel comfortable taking.
1. Calculate your financial goal, the amount of money you hope to end up with as a result of your mutual fund investment. The cash you need to earn depends on how you intend to use it: a down payment on a house or a trip through Europe are likely to require less money than 25 years of retirement living.
2. Determine how much time you have left to reach your financial goal. If you are 40 and plan to retire at 70, you have 30 years to build your portfolio. On the other hand, if you just graduated from college at 21 and want the down payment on a house by the time you have turned 30, nine years are all you have to come up with the money. Since the return on mutual fund investments fluctuates and is not guaranteed, taking greater risks makes more sense when you have many years ahead. The long period to get to your goal provides time for your account to recover from big losses.
3. Divide your total investment among the three major asset categories -- stocks, bonds and money market funds -- considering the degree of risk you are willing to take and the time you have left to reach your financial goal. The U.S. Securities and Exchange Commission describes stocks as the riskiest option with the highest return. Bonds and money market accounts pay the lowest interest, but your chances of losing the principal invested is also small. If you do not tolerate much risk and you only have five years to meet your goal, keep a large percentage of your investment in bonds and money market funds. Limit your equity investment -- stocks or shares that do not guarantee a fixed interest -- to 10 percent, for example. On the other hand, if you are a young adult with long-term goals, start out with your entire principal invested in stocks, advises the website 401KHelpCenter.com.
4. Diversify your investment within each asset category. Fifteen percent to 30 percent of your stock portfolio should include foreign stocks, for example. Likewise, invest in high-yield bonds, which come with a great default risk but also pay high interest, and in low-risk bonds.
5. Review and revise your mutual fund asset allocations at least annually. Consider shuffling your investment when your financial goals or the market changes. Move your money to low-risk mutual fund assets as the date on which you want to reach your financial goal gets closer.
Items you will need
- Jupiterimages/Comstock/Getty Images