For most investors, the past 10 years were sobering. In the early part of this new century, rampant speculation drove hot growth stocks sky-high, which culminated in the tech-bubble burst. During the market's plunge in the latter years of the decade, some of the most trusted names in the financial sector came to the brink of collapse. Times have changed. The full-steam-ahead market we've grown accustomed to is likely to slow. In turn, so should your investing habits. Here are some tips on how to become a smarter, more frugal mutual fund investor.

Investing on the Cheap

When times are tough, it can be daunting to come up with enough cash to start -- or continue -- investing. But even a relatively small amount of seed money can pay off big in the long run: With an initial investment of $1,000 and monthly contributions of just $100, you could cash out with several hundred thousand dollars upon retirement. Here's how to get going with $1,000 or less:

ETFs.

Exchange-traded funds, which look like mutual funds but behave like stocks, offer a simple, low-cost way to invest and gain instant diversification. Investors can buy as little as one share of an ETF, whereas mutual funds often require upfront investments of $3,000 or more. Like index funds, most ETFs mirror an index and therefore don't require a manager, so fees are often minuscule (0.53 percent for the average stock ETF, according to Morningstar, although many charge much less). Small investors can theoretically create a diversified portfolio with just two or three ETFs. For example, you might pair iShares Barclays Aggregate Bond Fund (symbol AGG), which covers the spectrum of U.S. investment-grade bonds and charges an annual fee of 0.24 percent, with an ETF representing the entire U.S. stock market, such as Vanguard Total Stock Market (VTI), with a fee of 0.09 percent. Throw in an international fund, and you've got the world covered.

There is one major drawback: ETFs are traded through brokerages, which typically charge a commission every time an investor buys or sells shares. A $7 commission may not sound like much, but trading multiple ETFs -- or making periodic contributions -- can put a dent in a modest investment. One option is to find a brokerage that charges low commissions, then trade infrequently and hold shares for a long period of time. Free trades aren't unheard of, but they're not common. Brokerage Charles Schwab is now offering a better option for small investors: commission-free trades of its recently introduced ETFs with no minimum balance. They include U.S. large-cap and small-cap funds as well as international ETFs. Fees are low to boot: Schwab's U.S. Broad Market ETF (SCHB), which tracks an index of the largest 2,500 U.S. stocks, charges 0.08 percent in annual fees.

All-in-one funds.

Call it the lazy man's portfolio, but premixed funds offer instant diversification with no hassle. The Vanguard STAR Fund (VGSTX), for example, invests in 11 of Vanguard's stock and bond funds, including Vanguard Long-Term Investment-Grade bond fund (VWESX) and Vanguard International Value stock fund (VTRIX). STAR, which has returned an annualized 5 percent over the past decade and charges an annual fee of 0.32 percent, is Vanguard's only fund that will let investors in for $1,000 (all others require a $3,000 minimum investment). Other fund companies will waive minimums if you agree to contribute regularly. "Think of it as putting your investments on a regular schedule and putting them on autopilot," says Christine Benz, Morningstar's director of personal finance. T. Rowe Price offers more than 90 funds that require nothing upfront -- just a commitment to set up an automatic contribution of at least $50 per month. T. Rowe Price Spectrum Growth Fund (PRSGX), which has gained an annualized 3 percent over the past 10 years, offers broad exposure to the market: It's made up of 11 underlying T. Rowe Price stock funds and charges a reasonable annual fee of 0.82 percent.

Actively managed funds.

If you prefer the expertise of a professional stock picker -- and are prepared to pay a bit more in annual fees -- you can invest in an actively managed fund for as little as $250. For that amount, Pax World Funds offers a menu of socially screened funds, which take into account companies' environmental, social, and governance practices. Pax World Balanced Fund (PAXWX) provides diversification by investing in both U.S. and foreign stocks and bonds and has returned an annualized 3 percent over the past decade, ranking it in the top half of its category. The fund charges an annual fee of 0.95 percent. The Oakmark funds require a $500 minimum if investors agree to set up an automatic investment plan and contribute at least $100 on a monthly or quarterly basis. The flagship Oakmark Fund (OAKMX) is run by veteran manager Bill Nygren and invests in large companies he believes to be undervalued. It has returned an annualized 6 percent over the past 10 years and charges an annual fee of 1.10 percent. For fixed-income investors, Harbor Bond Fund (HABDX) holds a range of securities, including U.S. treasuries, corporate bonds, and foreign bonds. It's managed by PIMCO founder and bond guru Bill Gross and requires a $1,000 investment. Harbor Bond has gained an annualized 7 percent over the past decade and charges an annual fee of 0.55 percent.

Funds That Pay in Tough Markets

Funds that invest in dividend-paying stocks may not wow investors with eye-popping returns during bull market rallies, but their added yield can provide some cushion in devastating bear markets. Some blue-chip stocks consistently pay out dividends year after year, and although the companies can cease those payouts at any time (as many financial firms have), mutual funds that invest in dividend-paying companies can pick and choose to provide a steady stream of income. From 1926 to March 2009, 44 percent of the total returns of the Standard & Poor's 500 came from reinvested dividends, according to S&P data.

Capital appreciation, or growth, is what investors generally think of when it comes to returns, but stable income on the side can be helpful in periods when markets are falling or at a standstill. "There's the capital appreciation, which usually is the bigger component of your total return . . . but the income portion can really hold you in good stead when the market just isn't moving anywhere," says Jeff Tjornehoj, Lipper's research manager for the United States and Canada.

Equity income funds invest in dividend-paying stocks or a mixture of dividend-paying stocks and bonds. The average yield of equity income funds was 3.45 percent at the end of December, compared with an average yield of 1.90 percent for stocks in the S&P 500. Aside from that additional income, these funds have other benefits: "Dividend-paying stocks help out on the risk component side of things," says Todd Rosenbluth, an equity analyst for Standard & Poor's. "Companies that historically pay dividends tend to have less volatility and have more consistency, which is a positive thing when you're investing in a diversified portfolio."

Rosenbluth holds two Vanguard equity income funds in high regard: Vanguard Dividend Appreciation Index (symbol VDAIX), which contains companies that have consistently boosted their payments over time, and Vanguard Dividend Growth (VDIGX), an actively managed fund that focuses on strong, steadily growing companies. Both funds invest in a range of companies rated highly by S&P, and they both yield more than the S&P 500 average. Last year, the funds struggled to keep up with their peers, but both held up much better than most during 2008's market meltdown.

Don't Get Burned by Fund Fees

Now, more than ever, mutual fund investors should be aware of how much they're paying their fund companies in annual fees, which include administrative, marketing, and management expenses. Morningstar analyst Jonathan Rahbar says "keeping a blind eye" to these fees -- which, combined, are known in the industry as the expense ratio -- is one of the biggest mistakes mutual fund investors make. In fact, many investors jump into the newest, hottest funds without the knowledge that they carry some of the highest expenses. It's unclear what the future holds for the stock market, but one thing is certain: Mutual fund annual fees can really make a dent in your overall return.

Say two investors put $10,000 in two different stock funds. Given the possibility of a more subdued stock market, say both funds gain an average of 4 percent per year over the next 10 years. Fund A charges 0.5 percent in annual fees, and Fund B charges 1.5 percent. After 10 years, Fund A will deliver a return of roughly $4,000, about $1,300 more than Fund B. The more you invest, the larger the gap: After 40 years, the investor who chose Fund A will have accumulated about $39,000, while the investor in Fund B will have gained only about $26,000. To compare fund returns yourself, the Securities and Exchange Commission offers a mutual fund calculator on its website that takes annual expenses into account. Here are some tips for keeping fund expenses low.

Assemble a strong team of low-cost funds.

Look for the lowest-cost core funds available, Rahbar says. ("Core" funds are those that typically make up a large portion of investors' portfolios, such as U.S. large-cap funds.) Research shows that over time, the best-performing funds are often the cheapest. Fees compound over time -- the same way returns do -- and lower fees mean managers have a lower hurdle to clear to beat their benchmark. Cost aside, look for managers who have a solid long-term record in both bull and bear markets and invest with a long-term horizon. Rahbar recommends that investors limit more aggressive funds with loftier fees to a smaller portion of their portfolio.

Compare fees among funds.

Large-cap funds are generally the cheapest to own. The median annual fee for no-load, large-cap funds is 0.95 percent, while the median for small-cap funds is 1.20 percent and for international stock funds, 1.23 percent, according to Morningstar. Because smaller companies require more research on the part of managers, they tend to be more expensive. The same goes for specialized funds, such as those that invest in a particular sector. Of course, you need to diversify, so you can't avoid paying more for some funds -- just be aware of how funds' expenses stack up against those of their peers. Investing in index funds is one way to keep expenses down (since these funds merely track the market, a paid stock picker isn't necessary). For broad exposure to the universe of large-cap stocks, Rahbar suggests investing in S&P 500 index funds. There are also a number of low-cost, actively managed funds that offer diversified exposure in each asset class.

Watch out for loads.

Sales charges -- also called loads -- can be a frugal investor's enemy. There are two types of sales loads: Front-end loads are upfront charges, and back-end loads are applied when an investor sells a fund. Loads are usually waived when investors buy funds through a financial adviser, and they're also waived in 401(k) plans. Otherwise, Adam Bold, founder of the Mutual Fund Store, says investors should steer clear. "Remember that when you pay a load, the load does not go to the mutual fund company; the load goes to the broker who is selling you that fund," he says. To put it into perspective, consider the above example, but this time add a front-end load. A 5 percent sales charge on a $10,000 investment means you're handing over $500 upfront.

 

Investing - Make the Most of Your Mutual Fund Money

(c) 2010 U.S. News & World Report