• / Free eNewsletters & Magazine
  • / My Account
Home>Research & Insights>Investment Insights>Two Things to Consider Before Picking Funds

Related Content

  1. Videos
  2. Articles

Two Things to Consider Before Picking Funds

Think about your goals, and learn about market history.

John Coumarianos, 01/05/2010

Is a Morningstar mutual fund analyst really telling you that other issues are more important to consider than deciding which mutual fund to own? Yes.

Many investors spend too much time thinking about individual mutual funds and too little time thinking about more important investment questions such as their goals and overall asset allocation. Two such issues should take precedence over the consideration of specific funds. Only after you've addressed them should you begin thinking about which funds are appropriate.

Know Your Goal
Before coming to Morningstar I worked as a financial advisor, and I was amazed by how many clients just "wanted to make money" but couldn't articulate a specific goal for the money they were investing.

My clients weren't completely off base. Having and making more money is clearly better than having and making less, or losing money. But people have specific financial goals to meet. Some of the most common are paying for their kids' college educations, owning a home, and providing for retirement. A simple desire to have and make more money without thinking about its specific purpose can get you into a heap of trouble.

A big challenge is that different goals require different time horizons. An area offering the potential for high gains can be the right choice in some cases but not others. In retrospect, a high-yield bond or emerging-markets fund clearly would have been great to own in 2009, as the Merrill Lynch High Yield Master II Index and the MSCI Emerging Markets Index have gained 57% and 77%, respectively, for the year to date through Dec. 28. But they wouldn't have been appropriate places for money that an investor planned to use to buy a home in the middle of 2010 or for the entire allocation of Junior's college fund, out of which the first tuition payment is due next September. Big near-term losses are just too common in these asset classes. For example, if one had to meet those goals in 2008 or early 2009, the results could have been catastrophic; those same indexes plummeted 26% and 53%, respectively, in 2008. And there was no guarantee that those asset classes would bounce back so well in 2009.

The appropriate place for money that you'll spend within two years is in cash--a money-market fund or a certificate of deposit. For a time horizon of two to three years, you can consider a conservative short-term bond fund or an ultrashort bond fund. Anything else is too risky. Then you must be prepared to see the return on that investment lag many other choices. In fact, it's virtually guaranteed that some asset class or sector funds will dramatically outperform that money-market account safeguarding next year's tuition payment or down payment for a house. Learn to live with the fact that returns on short-term money may look weak next to alternatives.

In short, getting the best possible returns on that money isn't the point; protecting it from loss is more important. Certainty comes at a price.

Understand Market History
Over the long haul, stocks have been better performers than money markets and short-term bond funds, but they're no panacea. Knowing market history can help you build a successful long-term portfolio that neither overdoses on stocks nor avoids them altogether.

©2017 Morningstar Advisor. All right reserved.