There are almost as many ways of investing in mutual funds as there are mutual funds, and there are an awful lot of mutual funds.
Experts say there may be more than 2,000 funds on the market now. They run from very specialized to the very broad.There's one new fund, for example, that invests only in stocks of foreign utility companies, while there are asset allocation funds that invest in stocks, bonds, gold and real estate.
Some funds are heavily managed: There are mutual funds that exist only to actively trade shares of other mutual funds. And others are hardly managed at all, such as the index funds that only try to mirror, not better, the Standard and Poor's index of 500 stocks.
The runaway growth of mutual funds over the past few years can be laid to the "if you can't beat them, join them" philosophy of investing, according to Michael Hirsch, senior vice president of Republic National Bank of New York and a mutual fund expert.
Hirsch says people who in the past might have bought and sold individual stocks have been frightened out of direct participation by the large institutional investors. Instead, these individuals are joining institutions themselves by investing through large pools of cash that mutual funds represent.
Hirsch believes that individual investors have "no business" buying and selling individual stocks.
He warns that it is like "sitting down at a poker game with a $50 stake when everybody else has $10,000. You can be the best player in the world, (but) it's only a matter of time before you're wiped out."
Unfortunately, the wide array of mutual funds choices has become as daunting for many as the stock market. An individual investor, looking for a solid fund or two in which to sock away money for retirement, can become paralyzed from the profusion of choices. How should the small investor start in funds?
Every expert has his or her own strategy, but all agree on one point: The better mutual funds will be those that have performed better in the past. Although financial markets change, the solid funds remain solid.
"It's amazing to me," said Wesley Johnson, an independent broker in Colorado Springs. "I've been tracking 1,500 funds for five years, and the good funds are always good, the mediocre funds are always mediocre and the poor funds are always poor."
A good starting point, then, is to check the mutual fund rankings that many magazines publish to see which funds have consistently performed strongly.
The emphasis is on consistency.
"I'm not talking about the supernovas, the one-year hotshots," said Hirsch, of Republic National Bank. Look for funds that have performed well over many years, he says.
How many funds should you invest in?
That's a good question to arouse the experts. Hirsch, whose views are controversial in some financial circles, believes no one should invest in fewer than five funds and that there's no maximum amount to own. Fifty funds or more are fine with him.
Hirsch recommends that investors diversify to the maximum, putting only the minimum investment of $1,000 to $2,000 in each fund before moving on to the next. Instead of owning one growth stock fund with $10,000 in it, Hirsch says the wise investor should own five with $2,000 in each. Diversify by type of investment, fund family and fund manager, Hirsch says.
Johnson is at the other extreme. Diversification merely waters down the gain, he believes. He tells his clients to pick a small handful of the most promising funds and put all of their eggs in one, two or three baskets. His approach can generate big gains, and big risks, for clients.
More typical is the view espoused by Ron Rough, the research director for Schabacker Investment Management, a Potomac, Md., money management and newsletter publishing firm. Rough believes investors with portfolios of about $20,000 should aim for about five funds, diversifying not by management firm but by type of investment.
For instance, Rough recommends a core investment of a growth stock fund, with added money in bond, money market, gold and perhaps international stock mutual funds. He believes the beginning mutual fund investor should find one mutual fund family to stick with.
That brings up the issue of whether it's worth paying fees to buy mutual funds. The research is clear that as a group, funds that charge fees do not provide higher returns than their no-load or low-load cousins, which have no sales fees or very low fees. Investors who are willing to do their own research and fund selection should stick primarily to the no-load and low-load list.