How you construct your mutual fund investment depends largely on personal preference. Here are some general guidelines that will help you figure out what will suit you best.
The first thing you need to do is define your objectives. What are you saving for, and how long do you have to reach that goal? For example, the mutual funds you select for retirement savings are different than, say, if you are saving for a house.
Next, you need to understand your "comfort zone" between risk and return. If you want the best return on your investment, you'll have to take more risk. For example, if you are a nervous Nellie and are saving to buy a house in three years, you are not going to look at stock market-based mutual funds. They are simply not in line with your time horizon or risk tolerance.
OK, let's say you've defined what you are saving for and know your tolerance for risk. Now it is time to start building. If you're investing for growth, start with what's known as a "large cap fund." A large cap fund is a collection of companies with a market capitalization value of more than $8 billion. This will be the core of your portfolio.
Next, pick some funds that add a little excitement to your mix. Remember, when building your portfolio, diversification is the key.
It doesn't matter if you have three funds or 10; make sure they are comprised of a variety of companies. Choosing a variety of funds will increase the likelihood that at least one of your funds is doing well at a given time.
So what kind of funds offer a little more excitement and possibly better returns? Look at funds that are comprised of smaller companies, developed international markets and possibly emerging markets. Emerging markets are up-and-coming economies around the world. They have the greatest promise for growth but are also the riskiest.
Remember, balance is key. When looking at a fund, ask yourself, "Does this fund fill a gap in my portfolio? Does it give me access to an area in the marketplace where I am not currently invested?" Now you are talking Wall Street!
A word about Uncle Sam: Be aware that unless you are investing in a 401(k), IRA or annuity, you'll be paying taxes on any money you make from the funds. A strategy here is to invest in funds that generate strong after-tax results.
Once you have chosen your funds, set up an automatic monthly withdrawal from your bank account. This approach is called dollar-cost averaging. By contributing monthly into a certain fund, more shares are purchased when the prices are down and less when the price goes up. Over time, you will pay an overall lower cost for your shares.
So weigh the risk and the return. Mutual funds can be very lucrative and fun investments if you do your homework upfront.