DISCLAIMER: I’m not a financial planner. The opinions stated in this blog post are my opinions based on my current financial portfolio and the hours of reading and research. I suggest everyone to also perform your own research since everyone’s financial portfolio are uniquely different.
A few weeks ago, I posted a “Vanguard Mutual Fund Reference Guide” and actually wrote quite a bit afterwards intending the guide and this post to be a mini-FAQ for any readers interested in investing or anyone not sure how to pick mutual funds. Although everything mentioned is strictly related to Vanguard, other financial institutions will have similar mutual fund options that I’ve listed. Remember, do your own research and retirement planning and investing is a long term endeavor!
Vanguard is one of the top financial institutions that provide retirement accounts. Many investors recommend opening up a Vanguard account for retirement since Vanguard offers a wide variety of options for investing. However, the number of funds that they offer can be overwhelming. Over the past 15 years, I’ve come to learn a lot about personal finance and investing. In this post, I will try to explain and simplify these mutual fund choices based on the research that I have done.
Mutual funds are an investment diversification tool. Within their portfolio, the funds can contain various asset classes such as stocks, bonds, real estate, or even cash that appeal to the investors. Generally, mutual funds are populated with stocks. Most mutual funds also focus the portfolio investments around a certain “theme.” One of the most common “themed” mutual funds is based off an index (S&P 500, Whole Market, etc) which seeks to mirror the stocks listed in these indexes. These types of funds are generally known as “index funds” and are relatively solid investments if you’re not sure what funds to invest in. Another common “themed” based mutual fund is known as a Target Date Mutual Fund. This type of fund simply targets a retirement year (the Target Date) and adjusts the amount of risks the portfolio is exposed to as retirement approaches. This is a common “one stop shop” for many people who do not wish to perform their own research. Other common themes would include assets classes that focus on a particular sector of the economy (finance, healthcare, real estate) or focus on social movements like social injustice and climate change. I find there will always be some mutual fund that satisfies an investor’s goal or personal beliefs.
Diving into more details, mutual funds will contain a blend of asset classes (bonds, real estate, stock, etc) while other funds will only focus on stocks. Generally, the mutual fund will list the type of asset class that it’s categorized in. In the case of stocks, investors have subdivided stocks into three categories depending on the market capitalization (i.e. how big a company is): small ($0.3B to $2B), mid ($2B to $10B) and large ($10B+). There are various risks and rewards associated with market capitalization to be aware of. Small cap offer greater growth/value but also greater risks. Large cap offer consistent value but also offers minimal risks.
In addition to different asset classes, mutual funds are also divided into three distinct stock types: growth, value and blend. Growth funds contain a portfolio where a company prioritizes growth (and increased market capitalization) while Value funds contain a portfolio where a company might be undervalued relative to the market. Blend funds are a combination of both types. There is also a fourth option where the fund focuses on companies that consistently provide dividends to also consider as well. I’ll call these out as “Dividend funds” but they seem to be classified as Value. Dividend funds are a unique type of fund since they invest in stocks that provide consistent dividend income to the investor. There is a whole investment thought process that is devoted to investing only in dividend stocks such that at some point in the future, an investor could live off the income generated by these stocks. Overall, investors will need to read the fund objectives to determine which asset stock type is best for them.
Finally, mutual funds are not free. They charge an operating expense that’s known as an expense ratio. This ratio is the fee charged over the total fund amount. The fee is usually taken out of the return on investment. Why does this matter? Funds that have low expense ratios generally mean more money for your dollar. For example, a fund with a 0.4% ratio means the fund charges $4 for every $1000 invested. But a fund with 0.04% charges only $0.4 for every $1000 invested. Over time and compound interest, more of your money is invested and working for you. I also look at this ratio as a factor of whether or not the fund might be worth looking into.
If you recall, here’s the table of the various Vanguard mutual funds. If you only had enough money to invest in one fund, I suggest investing in either VFIAX/VOO or VTSAX/VTI. The VFIAX mirrors the S&P 500 while VTSAX mirrors the total market. A quick Google search will show you that funds mirroring large index funds like VFIAX will generally net positive returns in the long run.
|Market Cap||Growth||Value||Dividend||Blend||Total Market|
|Large Cap||VIGAX (Admiral)|
VEIPX (Admiral)VYM (ETF)
|Mid Cap||VMGMX (Admiral)|
|Small Cap||VSGAX (Admiral)|
Large, reputable retirement plans will offer a mix of growth, value and blend funds as well as large, mid and small cap funds. The company generally determines which funds to invest in but I suspect they follow the general advice of the retirement plans. Since retirement plans vary, doing your own research is important for your own specific plan. Just remember two key points. 1) Select one of the proven types of mutual funds like S&P 500 index funds or a similar large cap blend mutual fund. History has shown these types of fund have had consistent growth. 2) Retirement planning and investing is a long term endeavor. I recommend a “set it and forget it” mentality since you you won’t start to see gains immediately. But come back after 5, or 10 years, the compounding effect will be very apparent.