Squaring off goals and investments

ESTABLISHING realistic financial goals is an essential first step toward successful investing. Understanding the investments best suited to helping you achieve your goals is equally important.

Most invest to meet long-term goals, such as ensuring a secure retirement or paying for a child's college education, but many also have more immediate goals, like making a down payment on a home or automobile.

Mutual funds can fit well into either your long- or short-term investment strategy, but the success of your plan depends on the type of fund you choose. Because all funds invest in securities markets, it is crucial to maintain realistic expectations about the performance of those markets and choose funds best suited to your needs.

Recent returns in perspective

Successful investors base their performance expectations on historic average returns, and keep short-term market movements in perspective.

Although many investors have enjoyed strong returns on their investments in recent years-as the stock market has returned an average of nearly 18 percent annually over the past decade-the historic average returns since 1926 are about 11 percent. Experts remind us that the unprecedented returns of the 1990s are not likely to continue.

If your investment expectations are too high, and the market reverts to historic levels, you may fall to reach your financial goals. To achieve your goals, it helps to follow a few basic rules of investing:

*Diversify your investments;

*Understand the relationship between risk and reward;

*Maintain realistic expectations about investment performance;

*Keep short-term market movements in perspective;

*Consider the impact that fees and taxes will have on your investment return; and

*Remember that an Investment's past performance is not necessarily indicative of its future results.

Establishing an investment plan

Establishing Goals and Realistic Expectations. Determining your financial goals is the first step to successful investing. You may have immediate goals, such as making a down payment on a home, paying for a wedding, or creating an emergency fund. You may also have long-term goals, like paying for college or retirement. Establishing goals will help assess how much money you need to invest, how much your investments must earn, and when you will need the money.

The next step is to make a realistic investment plan designed to meet your goals. Setting realistic expectations about your investments and about market performance is an important part of your investment plan. Securities don't always rise in value, and when they fall, the downturns can sometimes be lengthy. A well-conceived, diversified personal investment plan can help you weather these downturns, and give you a measure of comfort when market volatility occurs.

Remember, also, that your plan should paint a broad picture of your personal financial situation now and where you want it to be in the future. In addition to goals, your plan should reflect your time horizon, financial situation, and personal feelings about risk. Establish your goals and create an investment plan now-the sooner you begin investing, the longer your money has to work for you.

Goals and time horizon

Generally, your goals will dictate how much time you have to invest. For example, if you are 35 years old and investing for retirement at age 65, then you have a time horizon of 30 years before you plan to begin withdrawing money. Identifying your time horizon is important because it influences how you invest. Typically, a shorter time frame necessitates conservative investments. A longer period allows you to handle more risk.

Start investing now

Compounding is the earnings on an investment's earnings. For example, if you invest $ 1,000 at a rate of 5 percent per year, your initial investment is worth $ 1,050 after one year. During the second year, assuming the some rate of return, earnings are based not on the original $ 1,000 investment, but also on the $50 in first-year earnings. Over time, compounding con produce significant growth in the value of an investment. So, the earlier you start investing, the faster your investments can grow in value.

Risk/reward trade-off

All mutual funds involve investment risk, including the possible loss of principal. Making an informed decision to assume some risk also creates the opportunity for greater potential reward. This fundamental principle of investing is known as the risk/reward tradeoff. When forming a plan, examine your personal attitude toward investment risk. Is stability more important than higher returns, or can you tolerate short-term losses for potential long-term gains?

Remember, investments that increase in value in a short period can just as quickly decrease in value. But if you've considered the risk/reward tradeoff, you know that investment volatility is a characteristic of a successful long-term plan.

Investment advice

Professionals such as stockbrokers, financial planners, bank representatives, or insurance agents can help you analyze your financial needs and objectives and recommend appropriate funds. In addition, fund organizations may maintain their own sales forces to help potential investors, or they may sell shares through outside professionals.

If you prefer to do it yourself, researching mutual funds and buying shares can be done through the telephone, mail, or personal computer. Many funds can be contacted directly to purchase their shares.

Establish Realistic Expectations

A fund investment can help you reach your financial goals, but mutual funds and the stock and bond markets are not an automatic route to financial security. That's why an important part of your investment plan is having realistic expectations about your funds and market performance.

Measurements of Performance

Total return is generally regarded as the best measure of fund performance because it is the most comprehensive. Total return includes dividend and capital gains distributions along with any changes in the fund's share price. A dividend distribution comes from the interest and dividends earned by the securities held by a fund; a capital gains distribution represents any net gains resulting from the sale of the securities held by a fund.

Total return, expressed as a percentage of an initial investment in a fund, represents the change in that investment's value over a given period, assuming any distributions were reinvested in the fund.

Yield is the measure of net income (dividends and interest less expenses) earned by the securities in the fund's portfolio during a specified period. Yield is expressed as a percentage of the fund's NAV (Including the highest applicable sales charge, if any). Yield does not include the change, if any, in the investment's value over a given period.

Key Performance Considerations

Past performance cannot predict future results. This year's top-performing funds aren't necessarily going to be next year's winners.

Short-term returns may not tell the whole story. Looking at fund performance over a longer period, such as 1 0 years, can give you a better picture of how the fund has performed during market fluctuations, and how it compares to funds with similar objectives.

(Edited-extracts from A guide to understanding mutual funds published by the Investment Company Institute (ICI) the apex body for mutual funds in the US. A complete 50 page booklet on the nuts and bolts of mutual funds is available on the ICI website, www.ici.org)