Expert: Paul Henneman - 11/29/2010

Question
I know their are no sure fire ways of investing without risk. I also know the market is susceptible to business cycles, and bear markets.

But are mutual funds generally (excluding a huge economic slump) safe and guarantee returns? I ask because I always hear of mutual funds just always growing. For example, I believe I read that vanguard grows like 12% every year or something.

Would the best way of investing for an investor who wishes to not manage his own picks and trades, be to invest into a mutual fund?

Should you go with a big name company? A local one? One with lots of money in it? How would you chose one?

Answer
Mike,
  Thank you for your question!
Unfortunately mutual funds are  by no means safe, and generally definitely do not offer guaranteed returns. I think that when you read about mutual funds growing, that usually refers to the amount of funds they have from investors, not the returns of the fund. Most mutual funds are basically invested in stocks of some sort, so if there are problems with the stocks they hold, then the performance of the fund will be poor.  Mutual funds are safer than buying individual stocks because a typical funds holds many stocks in its portfolio, so if one stock does not do well there are many others to dilute the importance of a single bad investment.
  The main thing is to consider mutual funds as basically an investment in the stock market. It is a relatively low risk way to invest in the stock market due to the diversity, but still risky. Some funds do much better than others, so if you choose your mutual fund investments poorly you will likely lose money.  Even mutual funds that perform strongly can have a change in managers or other issues that change the funds overall success going forward.
  To limit the risk as much as possible, most experts would say to invest in a large, well known fund that has relatively low management fees, and that is a simply fund to understand. For example, there are many funds that track the major stock market indexes.  The S&P500 is perhaps the best known index for this purpose, there are many funds that track the S&P500.   Basically you are investing in all 500 companies in this index when you buy into that mutual fund, so your funds are diversified across a large number of companies. But, if the economy in general does very badly as it has over the past few years, even this will not be enough to avoid large losses as most stocks in the S&P500 went down dramatically in 2007 and 2008.
   Bonds are typically less volatile than stocks, perhaps Bond mutual funds would be an alternative to look into.  The best, most stable approach is to diversify your investments into different categories: some in the stock market through mutual funds, some in bonds (also through mutual funds), perhaps some in Certificate of Deposits that offer very low returns, but are very safe.
   Also, ETF's (Exchange Traded Funds) are basically very similar to mutual funds, except that they generally have lower fees. There are many index tracking ETF's, as well as bond ETF's available.

I hope this helps, please do not hesitate to follow up with me if I can be of any additional service.

Sincerely,
Paul Henneman
President
ValuEngine, Inc
www.ValuEngine.com