For the average investor, a good tip for investing your money is to invest across a number of different mutual funds with each asset allocation of a mutual fund being the key to investment success. Choosing the best asset allocation strategy is very important when picking the best mutual funds to invest in. Here we look at how best to allocate your money in mutual funds: stock funds vs. bond funds vs. money market funds. These three main categories of mutual funds offer investors the best investment portfolio that satisfies their individual financial objectives. The average investor could invest in all three types of mutual funds in order to meet their savings and investment needs at various stages of their life. A quick and easy way to establish which category of mutual fund suits your needs is to determine how long you wish to save/invest for. If you wish to save for one month to one year, we would recommend that you invest in a money market mutual fund. However, if you intend on saving for between one and three years, a bond fund would be most suitable for you. Finally, if you wish to save for longer than three years, then we recommend an equity or multi-asset fund.
Money market funds are by far the least risky of the three types of mutual funds and typically offers higher rates when compared to a standard savings account. However, like all investment funds, these funds are not risk free and are exposed to reinvestment risk. Given the maturity profile of money market funds (30 – 365 days), reinvestment risk is higher in a money market fund than in a bond fund. On the other hand, a money market fund benefits from a rising interest rate environment.
A bond fund is a fund that invests in bonds or other debt securities. Some investors prefer to invest in a bond fund because they often have a dual investment objective, i.e. capital preservation and income generation. In addition, bonds are regarded as less risky than stocks but riskier than money market securities and are thus suitable for investors willing to take on some risk. When investing in bonds, an investor should bear interest rate risk in mind. There is an inverse relationship between bond price and interest rates. If longterm interest rates rise upward, prices of bonds will dip.
Stock funds are regarded as the riskiest of mutual funds, as stock markets can be highly unpredictable. These mutual funds are principally categorised according to the type of stock they invest in, the investment style of the stock in the portfolio, and geography. Investing in a stock mutual fund may carry higher risks than investing in bond or money market mutual fund, but their growth potential is also higher.
An example of how you can fully diversify your money is to invest 40% of your money in a bond-based mutual fund, 30% in a money market mutual fund and the remaining 30% in an equitybased mutual fund. A key benefit of investing in mutual funds is diversification. Diversifying further across a number of different mutual funds with varying risk and reward characteristics will lead to even more diversification benefits.
For the average investor with enough disposable income to invest in more than one mutual fund, this suggested asset allocation would produce optimal diversification. Your well-balanced investments across a number of mutual funds should shield you from heavy losses whilst positioning you for strong gains. This is what long term investment is all about.