How mutual funds can help you pursue your goals

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These flexible investments offer diversification and professional management. The key to using them well? Finding the right funds for your goals.

Key points

  • Mutual funds offer a combination of diversification and professional management that is both convenient and economical
  • Merrill Edge® fund screener tools can help simplify your task of choosing mutual funds
  • Actively managed funds can be especially useful in a challenging economic environment, while passively managed funds, which try to simply deliver the overall market experience, generally charge lower fees
Most of us are saving for a reason, whether to retire comfortably, fund an education or see us through an unforeseen financial challenge. That specific goal, in turn, shapes both the amount we need to save and how that money should be invested. That's where mutual funds come in. While individual circumstances and goals will vary greatly, mutual funds — when used strategically — can be beneficial in many situations.
"Your investment objectives, time horizon and individual personality help to determine your risk tolerance and ideal asset allocation — the mix of stocks, bonds and cash you want in your portfolio," explains Paul Riley, managing director, Merrill Edge Product Strategy. To help you determine your target asset allocation, Merrill Edge® offers an online Asset Allocator tool. Once you know your appropriate target asset allocation, you can use mutual funds to construct a diversified portfolio of investments to help meet your needs.
Although diversification does not protect against losses in any market, it allows you to spread investing risk within and across asset classes.

The basics of mutual funds

Before we delve into how you might best use mutual funds, it's good to review some basics. For the average investor, mutual funds offer several potential advantages over investing in individual securities:
  • Professionally managed to suit specific investment objectives, which means that fund managers do the time-consuming research and make the buying and selling decisions on specific securities and market sectors
  • Provide diversification across the many securities they hold
  • Accessible with low minimum purchase requirements
  • A mutual fund holds more securities than most investors could afford to buy on their own
However, investors should also consider some of the disadvantages of mutual fund investing:
  • Fund costs continue even when returns are negative
  • You can't control the makeup of a mutual fund's portfolio
  • The exact price at which you buy or sell shares in the fund isn't known until several hours after the close of the day's trading
  • Shares of funds held in taxable accounts may be subject to different types of taxes — such as income tax on dividends and capital gains from the sale of securities occurring during the normal operations within a fund — prior to your redeeming your shares
(You can learn more about mutual funds in the Learn more about mutual funds in the Morningstar Mutual Funds Classroom.)

Choosing the right fund for your needs

While mutual funds offer diversification and convenience, success, as with any investment, depends largely on choosing the funds according to a strategy that is based on your risk tolerance, financial goals and time horizon.
If you're an investor with less than $20,000 to work with, a single-fund solution may offer the most simplicity and convenience. By choosing a "target date" fund matching the date of your goal — the start of your retirement, for example — you get an asset allocation that is continuously adjusted from relatively aggressive to more conservative as the target date draws closer. Alternatively, you may choose an "asset allocation" fund that manages a mix of stocks, bonds and cash that matches a specific risk of tolerance, from conservative to aggressive. Asset allocation funds are appropriate, if your investment goals don't correspond to a particular date, or if you want to make decisions based on your risk tolerance rather than timing.
The more informed you are about your options, the greater your chances of designing the right mutual fund strategy for your investment goals.
If you're an investor with a portfolio of $20,000 or more, tailoring your mutual fund holdings to help achieve your goals may make more sense for your situation. For example:
  • If growth vs. value-style investing is appropriate for you, you can choose from funds with managers who are similarly focused
  • If you're retired or nearing retirement, you may want to take a more conservative approach with investments such as fixed income funds, growth and income funds, or balanced funds
Merrill Edge has tools such as Merrill Edge Select Funds and Mutual Funds Screener that can help you select the funds that are right for your situation.

Active vs. passive mutual funds: What's the difference?

Beyond considering which types of funds to buy, investors also need to decide between funds that are actively managed and those that are passively managed, notes Rajesh Kohli, director, Chief Investment Office at Merrill Lynch. Both management styles have pros and cons.
Actively managed funds have professional managers, who attempt to outperform defined market benchmarks such as the S&P 500. These managers have flexibility in choosing where to invest, as they are not trying to duplicate any one index or benchmark. Accordingly, actively managed funds:
  • May do better or worse than their benchmark
  • May perform better or worse than the overall market
  • May do well in markets that are inefficient — meaning those that are difficult to negotiate on account of, say, low trading volume or a lack of publicly available information — such as emerging markets
  • Require greater due diligence on the investors' part — investors should look for fund managers who consistently outperform the benchmark over time, while taking reasonable risks
  • May charge management fees that are higher than those of passively managed funds constructed to mimic a particular index; these expenses are typically charged for portfolio management and research
Passively managed index funds contain holdings that are automatically selected, with no input from active managers who might assess the specific companies or stocks, because the goal of these funds is simply to duplicate the performance of a specific index or benchmark. These funds:
  • Purchase only securities in a particular index, regardless of company performance
  • Perform as well or as poorly as the benchmark indexes they mirror
  • Generally charge investors lower fees, as there is no need for active management expenses
Kohli explains that many investors today are building portfolios that include both active and passive funds to take advantage of market opportunities and control overall expenses.

Mutual fund investing tips

Here are some tips to bear in mind when you invest in mutual funds:
  1. Don't chase performance. Check a fund's short and long-term-performance track record as well as its volatility compared to benchmarks or peers, keeping an eye out for red flags such as portfolio manager or investing philosophy changes.
  2. Know what you own. If you own shares in more than one fund, or in a fund and individual securities, look at the actual underlying holdings to ensure that you are well diversified, which can help your portfolio avoid unintentional overlaps of market sectors or individual security exposure.
  3. Monitor fees. Costs can add up, so make sure you are aware of the expenses of the funds you own and ensure you are receiving the value for the fees you are being charged.
  4. Keep an eye on taxes within your taxable accounts. For example, investing in funds with high turnover may result in an unexpected tax bill that's bigger than what you were expecting due to a mutual funds normal operating mode.
  5. Rebalance your portfolio. Make a habit of regularly checking your portfolio against your target asset allocation, and don't be afraid to make changes to your investments in order to maintain your desired investing profile.
Ultimately, the more informed you are about your options, the greater your chances of designing, and sticking to, the right mutual fund strategy for your investment goals. "There are literally thousands of funds, so chances are you can find investing options that suit your goals," says Kohli. Finding appropriate funds can be daunting, but a key objective for Merrill Edge® is to help simplify this task for you through:
  • Predefined quantitative quick screens to search for qualities like top-ranked funds based on rankings from third-party research firms such as Morningstar Inc. and Lipper
  • The complete mutual fund screener which allows you to choose your own criteria to help narrow down the investing universe
  • The Merrill Edge Select™ Funds, a directory of funds that have met our proprietary screening criteria
Merrill Edge offers more than 7,000 mutual funds including hundreds of no load and Morningstar® 4- and 5-star rated funds, all from well-known mutual fund families.
Next steps

For more complete information on any mutual fund, clients should obtain the prospectus, and/or if available, the summary prospectus, and should read it carefully. Before investing, carefully consider the investment objectives, risks, and charges and expenses of a fund. This and other information can be found in the fund's prospectus and/or, if available, summary prospectus. Prospectuses for mutual funds can be obtained through the investor's sign-in area of Clients of the Merrill Edge Advisory Center can also call 888.654.6837. If you're not currently a Merrill Edge client, please call 888.637.3343.

Investing involves risk, including possible loss of the principal value invested. Investments in foreign securities or sector funds, including technology or real estate stocks, are subject to substantial volatility due to adverse political, economic or other developments and may carry additional risk resulting from lack of industry diversification. Investing in emerging markets may involve greater risks than investing in more developed countries. Funds that invest in small or mid-capitalization companies experience a greater degree of market volatility than those of large-capitalization stocks and are riskier investments. Bond funds have the same interest rate, inflation, and credit risks associated with the underlying bonds owned by the fund. Generally, the value of bond funds rises when prevailing interest rates fall and falls when interest rates rise. Investing in lower-grade debt securities ("junk" bonds) may be subject to greater market fluctuations and risk of loss of income and principal than securities in higher rated categories. There are ongoing fees and expenses associated with investing. Bear in mind that higher return potential is accompanied by higher risk.

Target date funds: The target date for these funds is the approximate date when an investor plans to start withdrawing the assets from their retirement account. The principal value of these funds is not guaranteed at any time, including at the target date. These funds are designed to become more conservative over time as the target date approaches.

Rebalancing does not ensure a profit or protect against loss in declining markets.