Investing can be a great way to build your wealth but the question is, where should you put your money? If you’re a first-time investor, you may want to consider a mutual fund. But what exactly is a mutual fund and how do they work?
A mutual fund is one of the smartest and easiest ways to invest your money in the market. Read on to learn everything there is to know about mutual funds.
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Mutual fund basics: What is a mutual fund?
Before you learn how to invest in mutual funds you first need to understand what they are.
Mutual funds are one of the most popular and least stressful ways to invest in the market. Why? Because they are simple investments and are easy to use. The simplicity in mutual funds is not just appealing to first-time investors they are appealing to anyone wanting to invest because of the easy to understand structure.
Mutual funds are an investment strategy that allow you to pool your money together with other investors to purchase a portfolio of stocks, bonds, exchange-traded funds (ETF’s) or other mutual funds that may be difficult to recreate on your own. I like to think of mutual funds as a basket full of different investments. Your basket can hold various stocks or bonds or it can be a mixture of the two creating one mutual fund portfolio.
There has been an increase in popularity in mutual funds due to the simplicity and cost of investing. Often times beginning investors do not have the expertise or cash to build a portfolio one stock or bond at a time. That’s why mutual funds are key to building a good investment portfolio.
How are mutual funds managed?
Mutual funds can be managed actively or passively.
Actively Managed Mutual Funds
Actively managed mutual funds have portfolio managers who buy and sell investments for investors. Their goal is to try and outperform the market. Because these funds are managed the fees are higher.
Passively Managed Mutual Funds
Passively managed funds (which is what index funds are), follow a predetermined strategy and hope to mimic the performance of the market.
Which Is Better?
There are many different opinions and a lot of debates in the financial sphere but I am a firm believer in Passive funds!
What Are The Benefits Of A Mutual Fund?
There are 4 benefits I see when it comes to mutual funds: diversity, simplicity,
Diversity Of Mutual Funds
Because mutual funds hold a variety of investments it makes it much easier for investors to diversify their accounts. I am sure you have heard the saying “don’t put all your eggs in one basket.” In investing this is a 100% true. Not all investments perform well at the same time. Holding a variety of investments may help offset the impact of poor performers while taking advantage of the earning potential of the rest.
Simplicity Of Mutual Funds
Most investors do not have the skills, knowledge or time to manage their own investments. Mutual funds allow you to pool your money with other investors and leave the specific investment decisions to a portfolio manager. Portfolio managers decide where to invest the money in the fund, and when to buy and sell investments.
Accessibility Of Mutual Funds
Mutual funds are widely available through banks, financial planning firms, investment firms, and credit unions.
Versatility Of Mutual Funds
Mutual funds can be used to meet a variety of financial goals. The biggest benefit to these is the ability to pool your assets allowing you to invest in different industries and different types of stocks and bonds with the help of investment professionals. Pooling your funds with other investors can give you access to expensive investments you couldn’t afford on your own.
Types Of Mutual Funds
There are thousands and thousands of different types of mutual funds. But all funds typically fall into 3 primary categories, with others being variations of the primary categories. The 3
Some Of The More Common Mutual Funds
Money Market Funds
These are considered “safe” low-risk low return funds. They invest in short-term debt securities such as US Treasury bills and government bonds Money market funds are liquid investments which can also be used as an emergency cash fund while still obtaining higher returns than savings accounts.
Income Funds
Income Funds mainly focus on generating regular income for investors by investing in government and high-quality corporate debt. Retirees and conservative investors may be interested in these.
Equity Funds
These are your basic stock fund. They invest in individual stocks and carry the greatest risk as well as the greatest potential for returns. The objective of an equity fund is to seek long-term growth on your investment. These funds are good for investors who are in for the long haul and who are aware of the risk factors
Hybrid Or Balanced Funds
These funds hold both stocks and bonds aiming to provide a good mix of profit and security. These are geared towards investors who are looking for a mixture of safety, income, and capital growth.
Index Funds
These are a type of mutual fund that attempts to match a stock market index, such as the Standard & Poor’s 500 or the Nasdaq. They usually have lower management fees because they aren’t actively managed. Index funds have a tendency to mimic the same ups and downs of the market because they basically purchase the exact same stocks that are in a popular market- index.
Closed-End Vs Open-End Funds
Closed-End Funds
A closed-end fund has a specific number of shares available and no new shares are created after that point.
Open-End funds
With an open-end fund, as long as you want to buy shares, the company will sell them to you. They will happily take your money, add it to the portfolio, and create more if and when necessary shares. These are the majority of the funds on the market today.
What About Mutual Fund Fees?
When looking at different mutual funds you may see that some funds charge fees as a percentage of your total investment or one flat fee for purchasing more shares.
Load Fees
Basically, a load is a sales commission that the investor pays for investing in a particular fund. A front-end load fund is one that you pay a commission on when you buy the fund. A back-end load fund is charged when you sell your shares.
For example, if you want to invest $1000 in a mutual fund and there is a 6% front-end load you can expect to pay $60 in fees when purchasing, this means you are only investing $940.
A no-load fund usually has lower expenses because you aren’t paying commissions.
Which one sounds better to you, a load fund or a no-load fund? I know which one I would pick! The one without the fees. Look for funds with the lowest charges to ensure you are making the most out of your money!
Expense Ratio
What is an expense Ratio? An expense ratio is an annual fee expressed as a percentage of your investment that you must pay to cover the fund’s total annual operating costs. Ideally, I would look for funds that are under .50%. If you are able to find an expense ratio for under .25% Jackpot! Even better.
The Importance Of Dollar Cost Averaging And Low Fees
As you can see all of these fees can add up and take money away from your investment strategy. The higher the fees and expense ratios the less you will have in returns. This is what compound interest is all about.
How To Invest In Mutual Funds
Now that you understand some of the basics of how mutual funds work, let’s discuss how to invest in mutual funds. You’re in this game to make money, so let’s move forward and learn how you can invest in the best mutual funds to do just that.
Determine Your Investment Objective
What are you looking to achieve? Do you want to double and triple your investment, and are you comfortable taking on some risk to do so?
Figure Out Your Timeline
The amount of time you have your money in the market matters: The longer it’s there, the longer it can compound and help you better achieve your investing goals.
Research Your Fund’s Historical Returns
A mutual fund prospectus provides you with the fund’s past performance relative to its benchmark. Has it underperformed over the past five, 10, and 15 years? If so, I’d pick another one of the hundreds of mutual funds with a similar investing objective.
Find Funds That Are No-loads
Every fund has a different fee policy. Do your research to minimize your fees
What Is the Best Type of Mutual Fund to Invest in?
I have a bit of favoritism towards index fund investing. I like them because they are passively managed, have low fees, which make them simple and affordable.
How To Buy Mutual Funds
Just remember all stocks, bonds, and mutual funds involve some level of market risk. Investing is a long-term game. Some years the market loses money but more often than not the market goes up.
Saving Up For Your Initial Mutual Fund Purchase
Many mutual funds require a minimum initial investment. This is the amount of money you’ll need to have saved prior to buying shares on your first fund. On average, you expect to need anywhere between $500-$3000.
Where To Buy Mutual Funds
You can purchase mutual funds through an employer-sponsored retirement account like a 401k or directly from a discount broker such as Charles Schwab or Scottrade, the best way to buy mutual funds is through a mutual fund company.
Start your research with good no-load mutual fund companies such as Vanguard, or Fidelity. Remember, No-load mutual funds don’t charge sales fees which can be up to 5.75% of your purchase!!
Opening an investment account online is super easy. You will need to provide some basics information such as name, address, date of birth, social security
Final Thoughts
Mutual funds are a great way to begin investing as a beginner. If you are are looking for additional ways to invest for your retirement, you should definitely check out this article which goes into detail outlining the differences between a Traditional IRA and a ROTH IRA. I also recommend exploring the benefits of an HSA and how it’s truly the ultimate retirement tool!
