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Mutual Fund Education

The 7 Biggest Mistakes to Avoid When Investing in Mutual Funds

Aaron Levitt Sep 23, 2014

For investors, mutual funds continue to be one of the best ways to build wealth over the long haul. By pooling their money with other investors, portfolios gain powerful diversification benefits and the capacity to own a bunch of stocks or bonds with relatively little initial capital outlay. Add in the ability to dollar-cost average over the longer haul and it is easy to see why mutual funds are still the number one way most retail investors invest.

See also 7 Questions to Ask When Buying a Mutual Fund

Here are seven of the most common pitfalls that investors make when it comes to investing in mutual funds.


Chasing Stars


However, as they say: “past performance is no guarantee of future results.”

A recent study by McGill University found that by 2006 (before the 2007/2008 crash), only 0.6% worth of fund managers were able to keep-up their “superstar” status and beat the indexes over time. For investors, looking at longer term performance metrics makes more sense than betting on last year’s hotshot manager.

See also How to Read a Mutual Fund Table


Closet Indexing


Investors end up paying more in expenses and costs to basically track the market. If you’re looking to buy a large cap stock mutual fund and its holdings look an awful like the S&P 500, you’re probably paying too much for the fund.


Forgetting to Check Under the Hood


Investors must actually open up a prospectus and dig into the fund’s holdings to see how its assets are diversified.


Limitations on What It Can Own



Understanding the Risks



Overpaying


Be sure to see our Complete Guide to Mutual Fund Expenses

These expenses can eat up returns over the long haul and cost investors some serious coin. To combat this issue, investors need to compare the expense ratios of alike products – even at the same fund company. For example, the $231 billion PIMCO Total Return Bond Fund comes in several flavors for the same exact fund. Class A shares PTTAX come with a nasty sales load, while Class D shares PTTDX do not. Mutual fund investors have to see if they are getting the best deal or not and save on those costs.


Forgetting About Taxes


That “tax-drag” could make owning the mutual fund undesirable. While there are ways to avoid or defer taxes—like using an IRA or 401(k)—investors need to consider taxes as part of the planning stages when it comes to selecting a mutual fund.


The Bottom Line


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