The scariest thing about investing is trying to find the “right” stock.
We all want to choose a magical stock that will lead to untold wealth, but in reality, it doesn’t work that way for most people.
If you want to grow your wealth over time, you’re more likely to have success with funds. Learning how to use funds to invest in your portfolio can help you put together a long-term plan that can grow your wealth.
Why you should invest in funds
Not every investment is right for every person. However, there’s a good chance that you can benefit when you use funds to invest in your portfolio.
Instant diversity is one of the biggest advantages associated with investing in funds. Funds are a collection of assets that share qualities. When you invest in a fund, you gain exposure to everything in the fund.
There are funds for just about everything. You can invest in clean energy funds. You can invest in growth stocks. You can invest in dividend stocks. You can invest in a bond fund. It’s even possible to invest in an all-market fund that owns a piece of each publicly traded company in the United States.
When you find funds to invest in, you’re taking advantage of a wide swath of the market instead of relying on a few individual stocks. This is beneficial because, over time, the market as a whole trends up.
(While there’s a first time for everything, so far the market hasn’t lost in any 25-year period. Sure, there are down years and the market has freak outs. But over enough time, the trend moves higher.)
Individual stocks are a different story. Companies go bankrupt. Products become obsolete. Mergers lead to stock price drops on acquisition. If you invest in the wrong area, you lose — and you could lose big.
Funds help insulate against individual stock picking because the rest of the assets in the fund can make up for the losses sustained by a few individual stocks.
Mutual funds (and index funds)
Some of the most common funds to invest in are mutual funds. These collections of assets are designed to achieve specific purposes.
If you have a higher risk tolerance and are interested in growing your wealth more aggressively, you can invest in a mutual fund aimed at growth. Whether you want to invest in bonds, utilities, or the healthcare sector, it’s possible to find mutual funds that fit your needs.
Actively managed funds have people who decide which assets are included. Their choices are supposed to help increase returns using the criteria of the fund. Because there’s a manager researching and making decisions, these funds often come with fees amounting to between one and three percent of your fund account.
Index funds represent a subset of mutual funds. Rather than basing inclusion in a fund on the decisions of a fund manager (or a group of fund managers), index funds include assets based on the index being tracked.
For example, if you invest in an S&P 500 index fund, you’re investing in everything followed by that index. There are bond funds as well that track bond indexes.
Because index funds don’t require active management, they are often less expensive. You can usually find them charging fees well below one percent a year.
Exchange-traded funds (ETFs)
In recent years, exchange-traded funds have gained in popularity. These funds follow a group of assets, but they are portioned into units that sell like stocks on the exchange.
ETFs are easier to trade because they act like stocks when you buy and sell. Mutual and index funds require an entire closing process and the transaction generally takes longer. However, with ETFs you also pay a transaction fee in some cases.
You trade ETFs on an exchange, which you pay a fee for. In addition, many ETFs come with expense ratios (what it costs an investment company to operate the fund). The good news is that ETFs come with ratios as low as 0.04 percent, so even with transaction fees they can be good choices in terms of saving on fees.
It’s also easier to gain exposure to currencies and commodities through ETFs. You need to be careful because there are additional risks involved when you invest in commodity and currency ETFs, but for the person looking for a spicier portfolio, these assets can be interesting.
How to invest in funds
Of course, once you know the basics about funds, it’s time to figure out which funds to invest in.
The cornerstone of a fund-investing strategy is to look at what percentage of your portfolio is in stocks, bonds, and other assets. This is especially important when you’re first starting out and building a long-term retirement portfolio.
At the most basic level, investing in funds for your long-term retirement portfolio starts with an all-market stock fund and a government bond fund. Consider your desired allocation based on your risk tolerance, and buy a certain number of shares.
My retirement portfolio is 90 percent stock ETFs and 10 percent bond ETFs. As I get older, the ratio will shift.
To build your portfolio consistently over time, use dollar cost averaging to your advantage. Set aside a certain amount of money each month. If you have $200 to invest and decide an 80/20 stock/bond allocation makes sense for you, put $160 in the stock fund and $40 in the bond fund.
More than retirement
Funds aren’t just for saving for retirement. I use a plain vanilla S&P 500 index fund as my long-term emergency savings. I invest a set amount each month and if I need to liquidate assets later, I can sell a few shares.
My travel fund uses a different allocation than my retirement fund. Because I know I’ll need the money sooner, it’s a 70/30 stock/bond ETF split.
If you aren’t sure where to begin, there are plenty of tools that can help you start investing. Using a robo-advisor to help tweak your allocation can be one way to get a little help with your efforts.
There’s nothing sexy about investing in funds. You’re not going to see mind-blowing returns, but you will be more likely to see returns that keep pace with the market. Over a couple of decades, that can mean a comfortable retirement that provides you with enough money to meet your goals.
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