Common Mistakes in Mutual Fund Investing

Appropriate asset allocation, effective diversification and suitable fund selections are some of the fundamental goals that every investor should desire in a mutual fund portfolio. Whether an investor is in one of the various stages of asset growth or in asset removal, these goals are necessary for mutual fund portfolios to be successful. However, an investor can come across many roadblocks or pitfalls in the quest to attain these goals.Investment decisions without any strategy, probably the most frequent mistake in mutual fund investing. Many investors may actually define and identify their investment objectives, but then skip the next vital step in establishing a successful mutual fund portfolio: creating a detailed asset allocation strategy. Without a well-defined, appropriate asset allocation strategy that accurately reflects individual investment objectives and preferences (time horizon, return objectives, risk tolerance, etc), the selection of mutual funds is haphazard instead of a logical, clear-cut process. On the other hand, effective diversification is a direct result of an appropriate detailed asset allocation strategy that fits individual investment objectives and preferences. Effective diversification spreads investment assets among different fund categories to achieve both a variety of distinct risk/reward objectives and a reduction in overall risk. Proper asset allocation not only reduce adverse characteristics of over-weighting, under-weighting and inappropriate funds, it accurately matches fund categories and their percentage of portfolio assets to specified objectives.

Establishing a successful mutual fund portfolio is a three-step process:

• Identifying investment objectives and preferences, including portfolio amount, return objectives, time horizon and risk tolerance.
• Formulating a detailed asset allocation strategy by fund type category to reflect chosen objectives.
• Suitable fund selection to match each category.

The second step is the most challenging due to the abundance of asset allocation theories and strategies. Most asset allocation strategies fall into two groups: one primarily treats risk as a stock/bond allocation, with risk tolerance changing the percentage of stock and bond funds; the other is primarily a fund category allocation, with risk tolerance affecting the type of fund categories and their allocation percentages within a basic stock/bond allocation.