Key Points:

• Mutual funds offer a combination of diversification and professional management that is both convenient and economical.
• Merrill Edge fund screener tools can help simplify the task of choosing mutual funds for you.
• Actively managed funds can be especially useful in a challenging economic environment, while passively managed funds generally charge lower fees.

Most of us are saving for a reason, whether to retire comfortably, fund an education or see us through an unforeseen financial challenge. That specific goal, in turn, shapes both the amount we need to save and how that money should be invested. That’s where mutual funds come in. While individual circumstances and goals will vary greatly, mutual funds when used strategically can be beneficial in many situations.

Your investment objectives and time horizon help to determine your risk tolerance and ideal asset allocation the mix of stocks, bonds and cash you want in your portfolio, explains Paul Riley, managing director, Merrill Edge Product Strategy. To help you determine your target asset allocation, Merrill Edge offers an online Asset Allocator tool. Once you have that, you can use mutual funds to construct a diversified portfolio of investments to help meet your needs

Although diversification does not protect against losses in a declining market, it allows you to spread the risk within and across asset classes.

The Basics of Mutual Funds

Before we delve into how you might best use mutual funds, it’s good to review some basics. For the average investor, mutual funds offer several potential advantages over investing in individual securities:

• Professionally managed to suit specific investment objectives, which means that fund managers do the time-consuming research and make the buying and selling decisions on specific securities and market sectors
• Provide diversification across the many securities they hold
• Accessible with low minimum purchase requirements
• A mutual fund holds more securities than most investors could afford to buy on their own

However, investors should also consider some of the disadvantages of mutual fund investing:

• Fund costs continue even when returns are negative
• You can’t control the makeup of a mutual fund’s portfolio
• The exact price at which you buy or sell shares in the fund isn’t known until several hours after the close of the day’s trading
• Shares of funds held in taxable accounts may be subject to different types of taxessuch as income tax on dividends and capital gains from the sale of securities in a fund prior to your redeeming your shares

(You can learn more about mutual funds in the Morningstar Mutual Funds Classroom .)

Choosing the Right Fund for Your Needs

While mutual funds offer diversification and convenience, success, as with any investment, depends largely on choosing the funds according to a strategy that is based on your risk tolerance, financial goals and time horizon.

If you’re an investor with less than $20,000 to work with, a single-fund solution may offer the most simplicity and convenience. By choosing a target date fund matching the date of your goal the start of your retirement, for example you get an asset allocation that is continuously adjusted from relatively aggressive to more conservative as the target date draws closer. Alternatively, you may choose an asset allocation fund that manages a mix of stocks, bonds and cash that matches a specific risk of tolerance, from conservative to aggressive. Asset allocation funds are appropriate, if your investment goals don’t correspond to a particular date, or if you want to make decisions based on your risk tolerance rather than timing.

THE MORE INFORMED YOU ARE ABOUT YOUR OPTIONS, THE GREATER YOUR CHANCES OF DESIGNING THE RIGHT MUTUAL FUND STRATEGY FOR YOUR INVESTMENT GOALS.

If you’re an investor with a portfolio of $20,000 or more, tailoring your mutual fund holdings to help achieve your goals may make more sense for your situation. For example:

• If growth vs. value-style investing is appropriate for you, you can choose from funds with managers who are similarly focused.
• If you’re retired or nearing retirement, you may want to take a more conservative approach with investments such as fixed income funds, growth and income funds, or balanced funds.

Merrill Edge has tools such as Merrill Edge Asset Allocator, Merrill Edge Select Funds, and Mutual Funds Screener that can help you select the funds that are right for your situation.

Active vs. Passive Mutual Funds: What’s the Difference?

Beyond considering which types of funds to buy, investors also need to decide between funds that are actively managed and those that are passively managed, notes Rajesh Kohli, director, Investment Management & Guidance at Merrill Lynch. Both management styles have pros and cons.

Actively managed funds have professional managers, who attempt to outperform defined market benchmarks such as the S&P 500. These managers have flexibility in choosing where to invest, as they are not trying to duplicate any one index or benchmark. Accordingly, actively managed funds:

• May do better or worse than their benchmark
• May perform better or worse than the overall market
• May do well in markets that are inefficient meaning those that are difficult to negotiate on account of, say, low trading volume or a lack of publicly available informationsuch as emerging markets
• Require greater due diligence on the investors’ part investors should look for fund managers who consistently outperform the benchmark over time, while taking reasonable risks.
• May charge management fees that are higher than those of passively managed funds constructed to mimic a particular index; these expenses are typically charged for portfolio management and research

Passively managed index funds contain holdings that are automatically selected, with no input from active managers who might assess the specific companies or stocks, because the goal of these funds is simply to duplicate the performance of a specific index or benchmark. These funds:

• Purchase only securities in a particular index, regardless of company performance
• Perform as well or as poorly as the benchmark indexes they mirror
• Generally charge investors lower fees, as there is no need for active management expenses

Kohli explains that many investors today are building portfolios that include both active and passive funds to take advantage of market opportunities and control overall expenses.

Mutual Fund Investing Tips

Here are some tips to bear in mind when you invest in mutual funds: