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Know What You Want: Mutual Funds Not A Risk-Free Ride

It's that time of year again when experienced fund investors get to take a look at how their funds have performed over the past 12 months and wannabe investors think about funds they hope to invest in during the coming year.

To make sure that every investor keeps their wits about them as they peruse the mutual fund investment opportunities available to them, here are a couple of things to keep in mind as we approach the New Year:

First and foremost, know what you're buying into. With all of the late-trading and market-timing problems facing the fund industry today, there's certainly been no shortage of coverage given the "mutual fund" subject. But despite the recent media attention to fund improprieties, not everyone knows what mutual funds are and how they work.

In a nutshell, mutual funds are investment packaged products and are not the same as other investment baskets of securities like hedge funds, closed-end funds or exchange traded funds, (ETFs). Hedge funds require you be an "accredited investor" meaning that you'll need at least $1 million in assets before you can invest. They also aren't regulated the same as the open-end mutual funds most of us invest into are; their sales charges and annual expenses are typically higher than those on open-end mutual funds; and shares aren't purchased or sold every business day of the week---shares are limited and specific dates are set for their redemption.

Closed-end funds represent baskets of securities just as ETFs do. Neither one require the deep pockets that hedge funds do to invest in, and each one trades as stocks do---on an exchange all day long. It's also OK to purchase one share of either if you'd like. But when buying and selling shares of closed-end funds or ETFs, investors will have commissions to pay to their brokers.

You won't need a $1million to open a mutual fund account. Typically a few thousand, sometimes a few hundred or--- if you participate in a fund's monthly investment program--- even 25 or 50 bucks a month is enough to get you started with a mutual fund investment. You may purchase or redeem fund shares any business day of he week.

Mutual funds offer anyone who is interested a chance to invest into a portfolio of securities that are professionally managed by one person or a team of people. Some portfolios may be made up of only stocks, others only bonds, still others, a combo of the two. Sometimes a fund's portfolio will hold a dozen or so securities in it; in others you'll find 100 or more. Portfolios may be diversified or concentrated; may hold large- medium- or small-cap companies it in; tax-free or corporate bonds, some of high quality others of lower-grade; or any combo of each.

Some funds may invest in stocks or bonds from other countries from about the world; others may concentrate their holdings in specific sectors, like health/sciences or technology; others in specific regions on the globe, like China or Latin America.

Of the more than 9600 stock funds that Lipper currently tracks, I'd say that while there may be similarities, no two are exactly the same holding precisely the same securities in the same amount in their portfolios ---with the exception of S & P 500 Index funds (these are designed to mirror the index and as such copy the index's holdings). That means, choosing a fund, or funds to invest in, requires time and research.

But before deciding whether or not to invest in a fund, it's important to understand that mutual fund investing is not risk-free investing.

The stock market has been kind to fund investors this year. Year-to-date through December 18, the average stock fund was up 31.61 percent, according to Lipper. That's a wonderful leap upwards and enough to make people forget the reality of the past few years. At year-end, 2002, for instance, the average stock fund was down 20.84 percent; at year-end 2001, the average fund was down 13.30 percent; at year-end 2000, when there were only 7,920 stock funds around, the average one closed the year down 4.51 percent.

But as the pros will tell you, when it comes to fund performances no two years are alike and a fund's past performance is no indication of how it will perform going forward. The primary reason for the future unpredictability is because of the market's unpredictability and the risks relating to investing.

For as long as there have been stocks to trade, there has been risks involved when deciding to invest in them. Mutual funds don't take the market risk out of investing but what a well-diversified portfolio may do is minimize the fall on the downside when the market is falling. A well-diversified fund can also limit the upside potential when prices on stocks are on the rise.

So, open-end mutual funds are not risk-free investments. Today they offer the same things to investors who don't want to select or manage a portfolio of securities on their own as they did in the 1920s when they were first created: A professionally managed product offering investment opportunities to those who hope to increase their wealth by investing in stocks, bonds or a combination of the two.

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