A solid financial plan makes use of a lot of different products and services. Some of them have very specific time constraints. For example, you renew your car insurance every year, and your term life insurance at the end of each term. Other products, including mutual funds, have no intrinsic timeline. Still, when you're in the early stages of retirement planning, it can be useful to think of mutual funds as a 20-year investment.
How Funds Work
Mutual funds harness some of the key principles of investing. One is diversification, or not putting all your eggs in one investment basket. By pooling your money with similar contributions from thousands of other small investors, the fund can purchase a diverse portfolio of investments. This provides protection against downturns in a single market or sector. Mutual funds also encourage consistent and frequent investing, often through a monthly pre-approved payment. This helps ensure you keep up the payments in good times and bad, which is exactly the discipline you need to succeed in investing.
The 20-Year Horizon
While you're juggling kids, bills and the mortgage, you might not have a lot of money to invest in your retirement plan. What you do have is time. If you're in your late 20s and plan to retire at 65, you have nearly 40 years for the markets to work in your favor. That's important, because the investments that bring the best long-term returns -- equity stocks, and the mutual funds that invest in them -- are variable in the short term, and can be stressful when the markets are down. However, if you plan to hold your investments for 20 years, a six-month "blip" becomes nothing more than a mental speed bump.
Choosing Your Funds
The core of your portfolio in the early years should be funds that shoot for large returns, usually called "growth" funds. They'll give you the biggest bang for your buck in the early days. Just be careful about buying "flavor-of-the-month" funds that tout their whopping returns over the last six months or so. Choose funds with a stable management team and a long history of positive returns. Pay close attention to costs; difference of 1 percent in management costs can sap a big chunk of your returns over time. Choose no-load or back-end loaded funds so your contributions go into the investment, instead of paying up-front commissions to a broker.
Holding Them...or Not
The key to a 20-year mutual fund strategy is to pick good-performing funds and hold them long term, even if the markets -- or a given fund -- take a dive for part of that time. A very good fund can perform below its peers for a while, as the result of specific investment positions. Sometimes, that's what actually fuels its stronger long-term returns. However, if a given fund lags behind its peers for two or three years, especially if the management team has changed, it might be time to switch to a different fund.
The Broader Strategy
Holding that early investment in growth-oriented funds for a minimum of 20 years provides ample opportunity for the markets to work in your favor. However, you still have nearly 20 more years left before retirement, so don't sell them just yet. Growth funds still have a part to play in your portfolio, though their role should diminish as your retirement approaches. One rule of thumb says the conservative percentage of your portfolio -- bonds, bond funds, interest-bearing investments -- should match your age. You'll still want some growth to generate strong returns, but keep the bulk of your capital safe to protect your lifestyle in retirement.
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