Mutual funds have something for everyone - at least Michelle Smith of the Mutual Fund Education Alliance thinks so."The industry has adjusted to the public's demand for choice," said Smith, who is managing director of the alliance, a nonprofit association that provides education to investors on mutual funds. "The public wants investment options, simplicity, low cost. They want help and advice and, in many cases, they want somebody to make it as simple for them as possible. It's a complete cafeteria of options."
In its annual study released in November, the Investment Company Institute, a national association of U.S. investment companies, found that nearly 55 million households own mutual funds, the highest number since the peak of more than 56 million households in 2001. Approximately $10 trillion is currently invested in approximately 8,000 U.S.-based mutual funds.
"The biggest trend or development that I see is more competition for mutual funds than there ever has been," said Eric Tyson, a financial counselor and author of several Dummies books, including ones on taxes, personal finance and mutual funds. "Hedge funds, exchange-traded funds, private money managers ... a lot of these entities are beating up on mutual funds as far as their sales pitches."
Tyson urged consumers and their financial advisors to sift through misinformation and marketing ploys to find the facts on a prospective mutual fund. "The worse thing a person can do is to start shopping around for funds without having a basic level of knowledge," he said. "All these different entities [mutual fund companies] have a vested interest. The key is to find an advisor who is competent and ethical. It's not always easy to find people who have both those qualifications."
Still, most invest in mutual funds because of the advantages of diversification and professional management opportunities, characteristics that may make investing more accessible to first-timers.
"Most people left on their own will invest in an undisciplined manner," said Sheryl Rowling, managing partner of Rowling, Dold & Associates in San Diego. "They are going to possibly buy or sell based on something they read or hear, they are going to be concerned with the short term as opposed to the long term, they aren't going to have the background and expert familiarity with whatever segment of the market the various mutual funds are targeting."
A smart investor, Rowling said, will first define their goals, develop their strategy and then invest accordingly, a process that should be facilitated by an advisor or manager.
"There are many funds and segments of the mutual fund industry that have stayed consistent in their strategy," Rowling said. "There are funds and managers that change their strategies periodically. I'm always very suspicious when people argue that there's a new economy and all the old rules don't apply. You see a big trend these days for alternative investments, including hedge funds. I don't believe that is entirely a new idea, although it tends to be a trend that people are looking at."
Aside from wrapping mutual funds into a "one-stop shop" package (sometimes referred to as life-cycle mutual funds) to simplify the massive choice of funds on the market, financial professionals predict that investors will turn to the global market for higher returns on their mutual fund investments.
"The mutual fund sponsors are coming out with newer and more innovative funds all the time, and I think this will continue to grow," said Louis Stanasolovich, founder and chief executive of Legend Financial Advisors in Pittsburgh. "From our firm's standpoint, we're very excited about these newer vehicles. There are a lot of specialty niche funds coming out."
He pointed to international real estate funds, commodity funds of all types, funds with hedge-fund structures, domestic or international, and value-oriented international funds as up-and-coming investment strategies.
"I think they will perform better and hence become more popular," Stanasolovich said of his list. "Most of the American public does not know about international real estate, but they are becoming more popular because of really good performance. They've been compounded over 35 percent per year for the past three years. There are more sophisticated strategies coming onboard all the time, not just stock funds, they're hedge-like in nature. I think that's the biggest trend."
In the next five to 10 years, however, Stanasolovich predicts a loss in investors, because the domestic stock market may not provide enough of a return for those investors to be satisfied.
Though Rowling wouldn't necessarily advise this track for her clients, she said that for the aging Baby Boomer generation, she sees more of an emphasis on income funds that provide a higher level of cash flow in the form of dividends.
A new emphasis is also being placed on index funds with higher-dividend-paying stocks, according to Tyson, rather than traditional index funds. The focus is more on investing in stocks that represent better values, which pay a better dividend.
Matt Gordon, managing director of financial planning for Lenox Advisors Inc. in New York, said that his firm is advising clients to diversify more into mutual funds that invest in large-cap companies, because that market has not had much growth in the last year. "What's happened across the board is that small-cap stock investments have done better than large-cap investments, and that has led to overweighting. We look at the past, but we're also looking at the future."
Gordon points to other strategies, such as commodity investments in gold and oil, as growing in popularity, as well as an emerging interest in iShares, a type of ETF that mimics index funds but has intra-day purchasing ability.
KEEPING AN EYE ON TAX
ETFs are becoming more popular because of their tax efficiency, according to Brian Garnets, an advisor with Sun Wealth Advisors in Jericho, N.Y. He said that because mutual fund investors aren't in control of when buying and selling occurs within a portfolio, more people are looking to ETFs as an alternative, since they can decide when the trading happens.
"People are becoming more aware and concerned about the tax consequences of investments in general," he said. "Therefore people are looking at mutual funds, saying, 'I'm not in control of the taxes.' ETFs are a way you're getting bundled products, but have more control."
Assets of all ETFs rose in October 2006 by $33 billion, or 9.4 percent, to $383.3 billion, according to figures released by the ICI. Over the past 12 months, ETF assets increased $119.5 billion, or 45.3 percent.
"It has sex appeal," explained Christopher Davis, an analyst for Morningstar, of ETFs. "I think people gravitate to them because they are the new innovative thing. In reality, they are mutual funds that just trade all day. It's true there are advantages to them in terms of tax efficiency and low expense, but those who trade them as stocks are going to undercut the advantages."
This year, Davis said, there aren't many changes that will affect investors. And for those conscious about tax efficiency, the advice is timeless: Think about what type of fund you want to invest in, whether it's a taxable or nontaxable account, and realize that just because funds are good, they doesn't mean they have strategies that are tax-efficient.
"I think a lot of people, when they see 'tax-managed,' they think they are getting short-changed on return," Davis said. "But the reality is a fund like this can give you better after-tax return. I think a lot of mistakes investors make are that they are so intent on avoiding taxes that they miss the big picture. You should invest to maximize your after-tax return."
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