Choosing investments doesn't have to be complicated. By estimating the amount you need to reach your investment goal, understanding your risk philosophy and choosing your desired allocation strategy, you've already done most of the hard work.
Now, you just need to select some investments to get you where you need to go. While some investors will choose individual stocks and bonds, others may gravitate more toward funds.
Funds: A Simpler Choice
In the Determining Your Asset Mix section, we discussed how asset allocation can be diversified across three basic asset classes: stocks, bonds, and cash. We've also discussed whether your portfolio will have any small-company or foreign-stock assets. But when you need to fill in the specifics by choosing actual investments, you may want a simpler choice.
Investors seeking simplicity may choose to go with mutual funds or exchange-traded funds (ETFs), preferring not buy stocks and bonds directly.
Why? Funds generally require less monitoring than individual securities do. Further, funds are usually well diversified--one fund can own hundreds of securities. As a result, they're less volatile than individual securities are.
Additionally, simplicity-seekers may also want to invest only in terms of core holdings. As we explained in the Core vs Noncore Investments section, some investors choose to focus on a few core holdings and try to achieve diversification strictly through their core investments.
If you're considering using funds in your portfolio, here are a few things you may want to think about:
- One way to gain U.S. stock exposure can be to include index funds in your portfolio's mix. You may be able to kill two birds with one index fund if you're able to find a fund that invests in the entire U.S. stock market and provides both large- and small-cap U.S. stock exposure.
- For foreign stocks, an index fund that provides market exposure in a single shot can make a solid core choice, as can an actively managed fund that provides geographically diversified exposure.
- When seeking fixed-income exposure, it's important to consider how interest rates and credit risk impact your investment strategy. Some investors may choose to look for high-quality, intermediate-term bonds that carry low expenses, while others may be willing to accept higher interest rates or credit risk in exchange for a greater return. You may also want to think about your tax situation when considering fixed income products. If you're in a high tax bracket and investing in a taxable account, you may want to consider a municipal-bond fund, because income from municipal bonds (or munis) is typically exempt from federal and, in some cases, state income tax.
- Lastly, it's important to remember that, even though funds may offer a simpler way to achieve a diversified portfolio, fund managers often charge different expenses and fees to cover their management costs. Two articles that can help you learn about different fund charges are Fees, which discusses different charges associated with mutual funds, and Compare ETFs to Other Products, which has an entire section devoted to different ETF expenses. It's also important to remember that the allocation strategy of a fund is handled by a manager, and some managers can choose to change their strategy without warning.
Read Next: How Many Investments Should You Have?
Investors should consider the investment objectives, charges, expense, and unique risk profile of an Exchange Traded Fund (ETF) or mutual fund carefully before investing. A prospectus contains this and other information and should be read carefully before investing. A mutual fund prospectus is available through www.scottrade.com or through a Scottrade branch office. An ETF prospectus must be obtained from the issuer.
Keep in mind that while diversification may help spread risk it does not assure a profit or protect against loss in a down market.
Bonds involve risk including, but not limited to interest rate risk, reinvestment risk, inflation risk, call risk, liquidity risk, credit risk, market risk, default risk, event risk, and a risk of loss of principal. New issue offerings are sold by prospectus or offering circular available at www.socttrade.com. Investors should read these carefully.
Please consult a tax, legal, or financial advisor with questions regarding your investment objectives and personal tax of financial situation.
The analytical tools described in this article are for information purposes only and their use does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security before making an investment decision.
