What are Mutual Funds?

Here is the definition of a Mutual Fund?

It can be overwhelming to start investing because there are so many terms to understand and beware about. One of the terms is Mutual Funds.

Definition: Mutual funds are professionally managed investment portfolios that allow investors to pool their money to invest in something such as Stocks or Bonds.

Many investment types exist today on the market. Mutual funds enable the investor to trade in many companies for a reasonable price.

A mutual fund is not limited to companies, as it is just a pool of money invested in something.

4 Categories of Mutual funds for FIRE

Even though Mutual Funds can be invested in nearly anything, you have to be very intentional from a FIRE perspective and have to see a certain amount of growth in your portfolio to reach your goals.

I will only consider Mutual Funds investing in Companies, rather than, e.g. Bonds. I have concrete examples of funds I’m investing in fitting in the below categories.

4 Types of relevance for FIRE:

1. Growth and Income

Growth and Income are funds of large-cap companies, which are matured and usually take part in the S&P500 index. The category is the least volatile group to invest in, however, also likely to return less than the other categories.

2. Growth

This fund category focuses on companies called Mid-large-cap companies. These still have lots of growth potential in them. This category tends to return higher than Growth and Income.

3. Aggressive Growth

Aggressive growth is a fund focusing on companies called small-cap. These type of companies tend to see high growth because they are yet to mature like Coca Cola. An Aggressive Growth company could be Tesla before it was obtained in S&P500. Emerging Market could also go into this category.

4. International

Because the investing world highly focuses on Wallstreet and US Companies. It is important to diversify into international based companies. They might have a presence in the US, but will be a non-US based Company like ISS, Maersk, or Orsted.

Now we have defined the group of Mutual fonds, which is relevant for FIRE. We can continue to explain the most common Mutual Funds.

What is Common Mutual Funds?

Today’s market is filled with options and places to invest in. However, if you dig into the FIRE communities, people tend to refer to the same group of Mutual funds.

If you have been following Dave Ramsey, you would know they are a big advocate of using Mutual Funds, rather than ETF’s or Index Funds. However, they never mentioned funds by name. Therefore, let me present some common Mutual funds.

A small disclaimer: These funds have been selected from the categories I might or might not be actively investing in the following funds. It is important to do your own due diligence before investing in any investments.

Above the table is only a few selected Mutual Funds available on the market. As a reader, you should note the funds are tracking different indexes or consist of different compositions. Therefore, it might make sense to invest in multiple funds even in the same category, if the holdings are not overlapping.

Dave Ramsay suggests having invested 25% each into each of the categories. However, it depends on your belief of the market, e.g. International funds above has only returned 5.19% since their inception and FSPSX only returned 8% in 2020. Therefore, I’m not doing a 25% split into all because the International fund consists of many companies simply not outperforming US-based companies. When the 5-year average passes the 8 or 10%, I might consider moving more into international funds.

What is the Risk of investing in Mutual Funds?

The risk will always exist when performing investments. For Mutual funds, it also bears the risk. The biggest risk when investing in Mutual funds or similar products is selecting a fund, which performs worse than others. Because a Mutual fund is highly diversified in nature, losing all your money, e.g. bankrupt, is nearly impossible.

How to avoid selecting bad Mutual funds?

Diversify

A mutual fund can consist of hundreds or thousands of companies, meaning it is already a very diversified investment product. However, simply selecting a single Mutual fund could turn out to be a terrible decision if this mutual fund is not performing well. Therefore, select a few mutual funds and look at their composition, so they are not overlapping too much.

Compare Mutual funds from the same category.

Although two mutual funds are in the same category as International, it doesn’t mean they are focusing on the same area or holding the same companies. Funds can be configured in many ways. e.g. some is focusing on China-based companies or Europe while some consists of all except the US. It can also be two funds to invest in the same companies. However, the weight of each company in the portfolio is different.

Look at the history of the fund.

Normal an investor would tell you history is not a guarantee of future returns. But it for sure does tell a story about a mutual fund. Suppose comparing two mutual funds where one return 10% since inception, compared to a 5%. I would definitely go with fund first unless something tells me the second has a better future return. Many look at the 1-3 year return, it can pose a risk because we might have had an exceptional year, and therefore the fund had an outstanding year. For a FIRE strategy, you have to think long term, therefore, look at the fund’s 5 or 10-year returns.

Compare the fee’s

Fees when investing is one of the most important aspects of selecting a fund. Why give your hard-earned money to someone else than yourself? Many actively managed funds have a high management fee. To create this article, I found a fund (I will not mention) had returned 12% since inception, Great right? It had a fee of whopping 3.4%, oh well, I’m only getting an 8.6% return. Watch out for management fees, because they will secretly eat your return. a Tip is Vanguard funds are usually among the cheapest in fees.