Beginning to invest -- regardless of how much you start with -- is not only admirable, but it's becoming a necessity for a lot of people. When you begin investing, one of the best things you can do is take advantage of funds instead of trying to pick out individual companies.
Of course, investing in funds is not foolproof, but it's very effective for many investors. If you're looking to begin, here are three mistakes you should avoid right now.
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1. Choosing mutual funds over index funds
Mutual funds and index funds are similar in that they're both baskets of assets you can invest in with one purchase, but there are key differences that warrant investing in index funds instead of mutual funds.
To begin, mutual funds are actively managed by professional investors, making them relatively costly thanks to fees. Index funds mirror a specific indexand are passively managed, making them much cheaper than mutual funds.
While a difference in fees may seem small on paper, they add up quickly over time -- especially when you take into account compound interest. Suppose you have two funds with expense ratios of 0.35% of 0.03%. Here's a rough difference in account value once you account for fees if you earn 10% interest annually.
| Monthly Contribution | Years | Total With 0.35% Fee | Total With 0.03% Fee |
|---|---|---|---|
| $500 | 20 |
$330,200 | $342,400 |
| $500 | 25 | $559,800 | $587,400 |
| $500 | 30 | $923,800 | $981,300 |
Data source: Calculations by author
2. Having too many overlapping companies
One of the best things about funds is that they provide a means to achieve instant diversification within your portfolio with a single investment. For example, the S&P 500 consists of the largest 500 companies in the U.S. If you invest in an S&P 500 fund, you'll be instantly invested in companies in technology, healthcare, finance, and almost any sector you could want.
Because companies can appear in multiple funds, you want to be careful with investing in funds that consist of a lot of the same companies because it takes away from your diversification. For example, if you already own a good amount of Apple and Microsoft shares, you likely wouldn't want to invest too much into a fund like the Vanguard Information Technology ETF (NYSEMKT:VGT) because Apple and Microsoft account for more than 37% of it.
3. Ignoring industry-specific funds
Although diversification is an important aspect of anyone's investment portfolio, you shouldn't shy away from including a few industry-specific funds. It's not uncommon for someone to be interested in an industry without a specific company sticking out to them. This can be especially true in emerging industries.
Instead of researching and picking individual companies, if you're interested in an industry, you can invest in funds that consist of companies in all aspects of the industry. For example, if you're interested in finance, you can invest in a fund like the Vanguard Financials ETF (NYSEMKT:VFH), which consists of some of the world's largest banks, insurance companies, and firms that provide other financial services. If you believe that eSports will continue growing, you can invest in a fund like the VanEck Video Gaming and eSports ETF (NASDAQ:ESPO), which consists of companies involved in developing video games, creating gaming hardware, and eSports competitions.
There are plenty of options available
There are more than enough fund options available to ensure you can invest in one that suits your needs. Whether it's by industry, company size, or social purpose, you can find the right mix for you. Just remember that one of the best things you can do is make consistent investments and let time and compound interest do the work for you. If you do that, you're destined to hit all your financial goals.
