The benefits of funds investing

Mutual funds and their close cousins, exchange-traded funds, share a lot of common benefits. The biggest difference between these two investment vehicles is that ETFs can be bought and sold during the trading day in the financial markets, whereas traditional mutual funds cannot and only trade at the closing price for the day.

     Here are the major benefits you receive when you invest in funds:

Professional management. Mutual funds and ETFs are managed by a portfolio manager and research team whose full-time jobs are to screen the universe of investments for those that best meet the stated objectives of the fund. These professionals call and visit companies, analyze companies' financial statements, and speak with companies' suppliers and customers. In short, the team does more research and analysis than you could ever hope to do in your free time. Fund managers typically are graduates of the top business and finance schools in the country, where they learn the principles of portfolio management and securities valuation and selection. The best fund managers typically have a decade of experience or more in analyzing and selecting investments, and many measure their experience in decades rather than years.

Low fees. The most efficiently managed stock mutual funds and ETFs cost less than 1 percent per year in fees (bond and money market funds cost much less). Because funds typically buy or sell tens of thousands of shares of a security at a time, the percentage commissions these funds pay are far less than what you pay to buy or sell a few hundred shares on your own. In addition, when you buy a no-load fund, you avoid paying sales commissions (known as loads) on your transactions. You can buy an ETF for a low transaction fee through the best online brokers.

Diversification. Fund investing enables you to achieve a level of diversification that is difficult to reach without tens of thousands of dollars and a lot of time to invest. If you go it alone, you should invest money in at least eight to 12 different securities in different industries to ensure that your portfolio can withstand a downturn in one or more of the investments. Proper diversification allows a mutual fund to receive the highest possible return at the lowest possible risk given its objectives. The most unfortunate investors during major stock market downswings have been individuals who had all their money riding on only a few stocks that plunged in price by 90 percent or more.

Short-term focus can be hazardous to your profits

Low cost of entry. Most mutual funds have low minimum-investment requirements, especially for retirement-account investors. (ETFs essentially have no minimum, although you won't want to do small transaction amounts because the brokerage fee will take up a larger percentage of your investment amount.) Even if you have a lot of money to invest, you also should consider mutual funds for the low-cost, high-quality money-management services that they provide.

  Audited performance records and expenses. In their prospectuses, all mutual funds are required to disclose historical data on returns, operating expenses and other fees. The Securities and Exchange Commission and accounting firms check these disclosures for accuracy. Also, several firms (such as Morningstar Inc.) report hundreds of fund statistics, allowing comparisons of performance, risk and many other factors.

         Flexibility in risk level. Among the different funds, you can choose a level of risk that you're comfortable with and that meets your personal and financial goals. If you want your money to grow over a long period of time, you may want to select funds that invest more heavily in stocks. If you need current income and don't want investments that fluctuate in value as widely as stocks, you may choose more-conservative bond funds. If you want to be sure that your invested principal doesn't drop in value (perhaps because you may need your money in the short term), you can select a money market fund.

Why stock buybacks are not always good for investors

Question: I haven't invested for many years, but I am having trouble following what my returns are in several mutual funds. I've started tracking the daily share price, but at the end of last year, some of the funds dropped a lot when they paid out something. So what do you recommend for tracking purposes?

  Answer: If you follow the price changes in your fund(s) every day, week, month or other time period, you won't know how your fund is doing. Share price is but one of the three components that make up your total return. And to make matters worse for the share-price hawks, another one of the three components - dividends - directly affects share price. When a fund makes a distribution to you, you get more shares of the fund. But distributions create an accounting problem because they reduce the share price of a fund by the exact amount of the distribution. Therefore, over time, following just the share price of your fund doesn't tell you how much money you've made or lost.

The only way to figure out exactly how much you've made or lost on your investment is to compare the total value of your fund holdings today to the total dollar amount you originally invested. If you've invested chunks of money at various points in time, this exercise becomes much more complicated. Some of investment software can help if you want your computer to crunch the numbers. Frankly, though, you have easier, less time-consuming ways to get a sense of how you're doing.

So, how often should you check on your funds? I recommend that you don't track the share prices of your funds every day. It's time-consuming and nerve-wracking and can make you lose sight of the long term. Worse, you'll be more likely to panic when times get tough. A weekly, monthly or even quarterly check-in is more than frequent enough to follow your funds. I know many successful investors who check on their funds' performance twice or even just once a year.

If you follow your funds through the daily newspaper or online and you see such a large price drop, look again to see if any special letters are printed after the fund's name, such as "x," which indicates that a fund paid its dividend, and "e" for payment of a capital gains distribution.

       Write Eric Tyson, author of "Investing for Dummies" and "Personal Finance for Dummies" via e-mail at eric@erictyson.com.