Posted: July 25, 2012
Three brothers and a cousin
How to choose the right fundBy Ron Phillips
There are many compelling investment ideas: It might be international stocks, a Dow Jones index, commodities, real estate, utility companies or tech stocks. No matter the investment, chances are there is a mutual fund for that.
But what kind of fund to buy?
THE OLDER SIBLING
The first U.S. fund type was the closed-end fund. These have a fixed number of shares and trade like a stock, changing value all day long. Many times the closed-end variety can sell at discounts to their real value. You can get assets for the proverbial “pennies on the dollar.”
Being smaller, they have their advantages. They are quicker to go up when they gain in popularity and hidden gems fly under the radar. Although an investor may face difficulties selling a large block of shares in a thinly-traded closed-end fund.
Another benefit to these funds is they can use leverage to magnify returns. Like being smaller, this leverage has the downside of added risk.
THE POPULARITY CONTEST WINNER
The open-end fund is the most-used mutual fund. They have the highest assets under management. Most 401k’s use them. Pensions and foundations use them. No-load funds are open-ended.
They play an important part in a portfolio. They are traded once at the end of the trading day. This makes the price less volatile than closed-end and other funds. Yet it creates some limitations, too.
They can not be liquidated quickly, be sold short or sell at discounts.
Exchange-traded funds are the newest fund type and a rapidly growing category. They have more assets than closed-end funds and are quickly gaining on open-end funds. They have a lot going for them.
They have very low annual fees. High-priced open-end funds can charge over two percent annually. Some ETF management fees are only 0.09 percent yearly. ETFs usually involve a commission to get in and out. This can still be very efficient. You might hold the ETF for 15 years and lower that average cost.
Most of the innovation happens with ETFs. There are new categories and asset classes created almost monthly.
THE DISTANT COUSIN
The least-used fund is the unit investment trust, or UIT. They were popular once but have severe limitations and share advantages that the other three execute more efficiently.
For example, a UIT is issued once and the buyer has to absorb a large commission, sometimes as high as 3.5 percent. They can be re-sold but it can create some lack of liquidity.
Also, the underlying portfolio “matures” and is then liquidated. Sorry buy-and-hold investors. Look elsewhere.
All four of these relatives offer diversification, professional management or strategies, reasonable costs and, hopefully, the ability to sleep at night. Knowing that your investments are not in a single, solitary stock, bond or other asset.
Ron Phillips is an Independent Financial Advisor and a Pueblo, Colorado native. He and his wife are currently raising their two sons in Pueblo. Order a free copy of his book "Investing To Win" by visiting www.RetireIQ.info or leaving a message on his prerecorded voicemail at 924-5070. Simply mention Promo Code #1001 when ordering.