It can be easy to buy mutual funds without doing your due diligence, such as with stocks. It may be wiser to assemble your portfolio so that each fund fills a specific role.
Strategies for mutual funds fall into three categories:
Here we’ll go into each timing strategy so you can learn how to maximize your mutual fund gains by creating one that’s right for you.
These are strategies that seek to make time an ally rather than an enemy. You can think of them as recruiting time for you instead of timing the market.
Dollar Cost Averaging and Periodic Investing
Dollar-cost averaging involves putting a fixed amount of money in one or more funds at set intervals, regardless of market conditions.
Because the amount you invest is always the same, you end up buying more shares when the price is low and fewer shares when the price is high. This strategy allows you to average out the market’s highs and lows.
Consequently, the average cost per share should be lower than the share price. So long as you buy at those set intervals and don’t get nervous when the market drops.
Be aware that the benefits of dollar cost averaging tend to diminish over time as the short-term price swings of a given investment begin to be less important than the overall direction of its price movements.
Investing a Lump Sum
If you have a large sum of money and plan to stay invested for a long time, some experts contend that your returns are better if that sum is invested immediately. This is because you’ll put your money to work fast and have a longer time for the benefits of compounding to have an impact.
The challenge with this strategy is that you run the risk of investing on the cliff’s edge of a downward turn. Though nothing can protect you completely from this possibility, you may be able to minimize this risk by spreading the money over multiple asset classes.
Also, be sure that you understand a given investment’s potential for both short-term and long-term losses as well as gains.
Though past performance is no guarantee of future results, knowing how a fund has behaved in both bull and bear markets, and how volatile it has been, can give you a sense of what’s possible in its future.
If you have chosen a selection of funds based on an appropriate asset allocation, you’ll likely need to adjust the amount of money in each one from time to time to maintain that asset allocation.
If one type of fund has done well, it might represent a higher share of your assets than you intended.
To maintain the desired percentage, you would sell shares of that fund and invest the money in a fund that represents a different asset class to bring it back to the appropriate level for your allocation. Or you could direct new assets into that asset class.
Buy and Hold
If your goal is to try to benefit from long-term upward price trends, you might adopt a buy-and-hold strategy, in which you identify what seem to be appropriate high-quality funds and hold them for a long time, trying not to be too concerned with day-to-day ups and downs.
Some benefits to a buy-and-hold strategy are:
- It’s an excellent way to avoid the expense and effort involved in frequent trading.
- It takes advantage of the compounding effect of reinvesting any dividend you may receive.
- Dividends can be automatically reinvested in additional full and fractional shares instead of in cash, and virtually all mutual funds allow you to reinvest dividends and capital gains distributions.
However, keep in mind that:
- You need to keep records.
- You will need a record of what you paid for them to determine your cost basis.
- That cost basis affects the amount of taxable capital gain (or tax-deductible capital loss) you realize.
While it seems simple, there are some things to keep in mind when employing a buy-and-hold strategy.
Buy and hold doesn’t mean holding on to a position after it’s outlived its original role in your portfolio, or just because you may have suffered a loss and cling to the idea of recouping that investment.
Even funds you plan to hold for a long time should be reexamined periodically to make sure they’re still appropriate in the context of your overall portfolio and any changes in your circumstances.
Timing the Market
While the above strategies involve recruiting time to your side as an ally, timing the market involves treating time as an adversary to be beaten. This is challenging at best. Even full-time professionals often have difficulty being successful at it.
Several studies have shown that when investors try to time the market, they often underperform a buy-and-hold strategy because they tend to buy close to market tops and sell near the bottom.
And even if all goes well and you can get out of a market in time to protect yourself from a downturn, will you know when you should get back in? Trading mutual funds is also difficult because they’re priced once daily, and so aren’t as flexible as vehicles that can be traded throughout the day.
All that said, if you feel confident attempting to second-guess the markets, several approaches may help.
You could adopt a core-and-satellite approach so that you employ market timing with only a portion of your portfolio. We will be exploring that later in the Selection Strategies section.
Also, be prepared to devote sufficient time to monitoring your investments closely so you can minimize potential
Finally, having an investment discipline and predetermined guidelines for buying, selling, and adhering to those guidelines can help remove emotion from your decisions.
Before attempting to time the market, you should be aware that many mutual funds impose redemption fees or other measures designed to restrict short-term trading. It’s especially important with this strategy to determine if such fees and trading costs will outweigh the potential benefits.
In some cases, closed-end funds, exchange-traded funds, or individual securities, which are all traded throughout the day, could provide an equivalent vehicle.
We continue with those in the next section.
As experienced financial professionals, we help clients like you figure out the best investment plan for their situation, so that they can put their money to work gracefully with peace of mind.
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