Warning: Is Your Mutual Fund Sticking To Its Objective?

mutual funds, investment tips, stock market

The following is a guest post.

Mutual funds are a great vehicle for an individual investor. Using funds allows you to invest in a diversified portfolio of stocks, bonds or other investments. Every mutual fund has a stated investment objective. It’s critical that you understand the objective and pay attention to changes in the investment portfolio. It you don’t, you may miss changes in your fund’s performance.

Your fund’s prospectus

The Securities and Exchange Commission (SEC) has oversight over the mutual fund industry. Funds are sold by prospectus. The prospectus discloses all of the critical information you need to know about your mutual fund. The fund’s objective will be clearly stated in the prospectus. In fact, your mutual fund must follow a set of guidelines to state their objective.

An example

Let’s assume that you’re a 30-year old investor. You’re willing to take some risk to earn a higher potential return on your investments. You have a long time until retirement, so you can make up for occasional losses by leaving your dollars invested for many years.

You decide to invest in stock mutual fund. You talk to a financial advisor and decide on American Fund’s Washington Mutual Investor’s Fund.

The fund’s objective

Washington Mutual’s website explains that the fund invests in “the bluest of the blue chips”. A blue ship stock is a large, well-established US company. These are company names you recognize: McDonald’s, IBM, Microsoft. Blue ship stocks have a long history of generating profits.

You’ll also notice that this fund can invest up to 10% of its assets in companies outside the US. This isn’t unusual. Nearly all mutual funds have an objective that allows the money manager to invest in securities that are slightly different from the fund’s primary objective.

Shifting from the primary objective

If your fund manager shifts away from the primary fund objective, the performance of your fund can be very different than what you expect.

Consider Washington Mutual. A portfolio with no investment in overseas stocks may perform differently than a fund with 10% in foreign stocks. Note that both scenarios fit within the investment objective.

Why the shift is important

Historically, fund managers have periodically shifted their portfolios toward high performing investments. The manager is trying to increase the fund’s rate of return. However, seeking a higher return can generate more risk.

In the late 1990s, for example, technology stocks were generating huge returns. Many blue chip fund managers shifted their stock ownership toward new, unproven companies in the tech industry.

During the early 2000s, many of the tech stocks fell sharply in price. Fund managers who added tech stocks to their portfolios also saw declines. Here’s the key point: the declines would have been less dramatic, if the fund manager had not shifted the portfolio toward tech stocks.

What you can do

Pay attention to your mutual fund’s performance. Talk with your investment advisor. Ask them if your fund has shifted the portfolio away from the primary investing objective.

If you make most of your investing decisions on your own, check on your fund’s performance each quarter. There are great independent research firms that track fund performance. Morningstar is a good example.

Mutual funds are a great way for an individual investor to build a portfolio. To get the investment performance that meets your goals, keep an eye on your fund’s investment objective.

Ken Boyd is the author of four Dummies books on accounting, including Cost Accounting For Dummies. He blogs on accounting and personal finance topics at Accounting


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