The best thing about a good retirement plan like the one offered to employees of Johns Hopkins University is that we have a large number of ways in which we can invest our retirement money. But sometimes it seems as if that’s also the worst thing about the plan. There are so many choices that it’s sometimes confusing.
The choices usually boil down to choosing mutual funds. Not too long ago, someone told me that he wasn’t exactly sure what a mutual fund was!
A mutual fund pools money together from investors. A professional manager decides to invest that money based on the fund’s objectives. The idea works well for small investors, who may not want to risk buying individual stocks because doing so puts too many eggs in one basket.
For example, an investor might decide to invest in the 500 largest companies in the United States. That investor doesn’t have the money to buy stock in each of those 500 companies. A mutual fund manager uses the pool of money in the mutual fund and buys stock in these companies on behalf of the investors.
There are mutual funds that suit the purposes of almost any investor. For example, Vanguard (like many other investment firms) has a fund called the Vanguard 500 Index Fund that invests in America’s 500 largest companies. Other funds, like Fidelity’s Select Biotechnology Portfolio, buy into specific industry sectors. Other funds might invest in a particular country or region. For example, Fidelity has a Japan Fund and a Europe Fund.
Some mutual funds are designed to enable investors to keep their choices in line with their beliefs and values. For example, TIAA -CREF’s Social Choice Equity Fund favors companies that treat the environment responsibly, serve local communities, make high-quality safe products, and manage ethically.
There are even funds that specialize in “sin” stocks. The USA Mutuals Barrier Fund invests in tobacco, alcohol, weapons, and gambling!
A useful distinction is between index funds and managed funds. An index fund (like the Vanguard 500 Index Fund) buys blindly into America’s 500 largest companies. In contrast, managed funds carefully select stocks or bonds to maximize the returns for their investors. There are advantages to both strategies. Many people believe that it’s better to have a well-diversified portfolio rather than to make bets on particular countries, sectors, or regions. Others think it’s important to be able to take advantage of financial trends. Typically, a managed fund needs more analysts and experts, and the cost of hiring these people is often high. The Vanguard Index 500 Fund, for example, has an expense ratio of 0.17%, while the Turner Medical Sciences Long/Short Investor Fund has a net expense ratio of 2.2%. So you need to manage the risk of your returns being spent on these expenses.
We cannot advise you how to invest your money on this blog, but any financially savvy person will tell you to make sure of two things. First, make sure that a fund’s management costs are not too high. Second, make sure your portfolio is diversified across a broad range of sectors, countries, financial instruments, and strategies.
The biggest mistake investors make is to try to chase the hottest funds in the hope of “beating the market.” A slow, steady, and deliberate approach is the path to financial security. It’s boring, but it works!