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Mutual Fund Investment Strategies

Mutual Fund Investment Strategies

Investments

May 22, 2024 22 mins read

If you’re new to investing or ready to diversify your portfolio even more, you’ve likely heard about mutual funds in some form or another. Like other investment products, adding mutual funds into your portfolio takes some serious consideration, including adopting one (or more) investment strategies. Now, we know you’re not necessarily trying to be the Wolf of Wall Street, but it helps to understan

What is a mutual fund?

Before you decide on an investment strategy, it helps to know some basic terminology. A mutual fund is a pooled investment opportunity that collects money from multiple investors and then invests in a portfolio of securities, such as stocks and bonds.

Fund managers manage the investment decisions on behalf of these investors by buying and selling the securities based on the mutual fund’s objectives.

As a whole, mutual funds attract investors for numerous reasons. For starters, a beginner or seasoned investor can invest in them. It offers portfolio diversification too, which means you spread your investment across numerous assets, which may reduce your risk. Plus, they typically have low fees (although this isn’t always the case, so check out each one’s fees).

5 mutual fund investment strategies

If you’d like to start investing in mutual funds or incorporate them into your portfolio, you may find numerous mutual fund options overwhelming. This is where having a mutual fund strategy can help, and you can pick one that aligns with your financial goals and how much risk you’re willing to take.

1. Index funds

An index fund strategy with mutual funds means investing in a fund set up to replicate the performance of a specific market index, such as the S&P 500. The fund includes a diversified portfolio of securities

This strategy is considered passive investing because it doesn’t involve active stock selection by a fund manager, which also means lower fees and minimal turnover – which simply means sticking with the same stocks. Index funds offer investors a way to participate in the overall market's performance without the need for individual stock research and selection.

Pros

Index funds offer portfolio diversification, low expense ratios, and low turnover since they don't require active management.
They can be an excellent choice for long-term, passive investors seeking steady returns with minimal fees.

Cons

Index funds only match the returns of whichever index they’re mirroring, so they won't outperform the market.
They can still experience losses during market downturns since they are fully invested.

2. Buy-and-hold

Another strategy is referred to as “buy-and-hold.” With this strategy, investors purchase mutual fund shares and hold onto them for an extended period — perhaps years or decades. The idea behind this strategy means riding out market fluctuations and really focusing (and hopefully capitalizing) on the long-term growth potential.

Investors using this strategy avoid frequent buying and selling, which keeps transaction costs at a minimum and potentially reduces capital gains taxes. The basic belief of this strategy is that investors can benefit from the compound growth of their mutual fund holdings.

Pros

Simple and straightforward approach without the need for active management.
Long-term growth potential is based on the overall growth of the market and the compound effect from reinvested earnings.

Cons

Investors must endure market downturns since they’re holding on to these mutual funds for the long term.
Due to market conditions, there is little flexibility and no role for active management of the fund if you want to change course.

3. Asset allocation

Another strategy is the asset allocation strategy. This involves dividing up a mutual fund's investments among various asset classes, such as stocks, bonds, cash, and other securities.

Investors who choose this strategy typically seek a diversified portfolio that balances risk and returns to match their goals and risk tolerance. When you spread out investments across various asset classes with this strategy, you’re trying to reduce the impact of market volatility on your portfolio while getting steady, long-term growth.

Pros

Diversification means you’re not dependent on one particular asset for investment.
You can customize the portfolio exactly how you want based on your own financial goals and risk tolerance.

Cons

The asset allocation strategy is more complex than other strategies because you have to understand each asset class and how they interact.
Changing market conditions can make it difficult to keep up with the various asset classes, so you likely have to make periodic changes to your portfolio.

4. Bond funds
The bond fund strategy means investing in a mutual fund that primarily holds a diversified portfolio of bonds. A bond is a debt security, or an IOU, issued by governments, municipalities, corporations, or other entities. In return, the investor receives interest for lending the money.
Bond funds invest in a range of bonds, each with its own maturity date, credit qualities, or interest rates, so it can achieve a specific investment goal. The strategy behind this is getting income for the investor through regular interest payments while managing any risk with the bond investments.
Pros
- Bond funds can offer a steady income stream thanks to the regular interest payments, making them an attractive choice for numerous investors.
- Bonds typically have lower volatility than stocks, making them more predictable, potentially stable, and particularly attractive for retirement accounts.
Cons
- Bonds are sensitive to market conditions, specifically changes in interest rates. When interest rates rise, bond prices usually fall, which can lead to a lower value.
- Bonds don’t have the same appreciation as other equities, so they might not be a high-growth opportunity like others.
5. Market-timing
Like the name suggests, this strategy attempts to predict the future movements of financial markets, such as the stock market, to buy or sell mutual fund shares at specific times. The idea behind this is to maximize profit while avoiding loss.
Investors who take on this strategy believe they can accurately predict when markets will rise or fall and adjust their mutual fund holdings accordingly. For example, they may try to buy funds just before they anticipate a market upswing and sell before they expect a downturn.
Pros
- If timed correctly, higher returns can be obtained from other forms of investing.
- You can avoid market downturns (again, if you time it correctly), which means potentially avoiding as much loss during a downturn as possible.
Cons
- Timing the market is not only extraordinarily difficult, it makes it hard to stay consistent with success.
- It’s an extremely risky strategy that can lead to significant losses, potentially wiping out any gains and long-term performance.