How to Diversify a Mutual Fund Portfolio

Investing in mutual funds is an excellent vehicle to fund a person's retirement. If the mutual funds are not properly diversified, however, that retirement could be put on hold. Protecting a portfolio against fluctuations in certain markets is essential to long-term financial health.

Instructions

Difficulty: Moderately Easy

1. Identify the investment objectives of the portfolio. What is the time horizon? In other words, when are the funds in the portfolio going to be needed (10, 20, 30 or more years)? What is the amount to invest in the portfolio? What are the return objectives? Finally, what are the risk tolerances of the investor? All these factors relate directly to the construction of a diversified portfolio.
2. Formulate an investment strategy. The strategy is based on the information obtained in the previous step. With a portfolio that has a high-risk tolerance and a long time horizon, the strategy will include more mutual funds with higher risk but higher returns as well. It is also very important to remember that even in portfolios that possess a high-risk tolerance; they must contain some lower risk funds to balance the portfolio.
3. Ascertain which type of mutual funds to invest in. The investment strategy determines which type of mutual fund and how much to invest. The types of mutual funds include money market, bond, stock and index funds. Each type carries its own risk factors. Some are less risky, like money market funds.
4. Categorize potential mutual fund sectors to invest. Obtain a candidate list of mutual funds sectors that fit the established investment strategy. Investigate each sector performance over a number of years. Compare and contrast the performance of each. Then use the investments strategy to identify the best funds to invest in. Examples of sectors include but are not limited to retailing, technology, industrials, communication, energy, commodities and pharmaceuticals.
5. Invest in the mutual fund, now that the fund is targeted. One important note before investing in a fund is to determine the cost of the fund and the minimum investment required for the fund. Sometimes the mutual fund fees can outweigh the benefits of investing in the fund. In addition, if a fund has a minimum investment that is too high it can cause imbalance in the portfolio. So be sure to check the fine print before investing in any fund.