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Ultimate Beginner’s Guide to Trading Mutual Funds

Trading mutual funds may seem intimidating to beginner trader, but you can follow some specific steps to make sure you start out strong. These funds come in a wide array of forms, each of which has different asset groups and requires different investment strategies. Additionally, they have fee structures that aren’t easy to understand. However, trading in mutual funds gives you another avenue to increase your profits and allows you to diversify your investments and mitigate your risk. This article covers the basics of mutual fund trading to help you get started.

  • A mutual fund refers to a company that pools money from different investors and invests it in stocks, bonds, and other assets.
  • Mutual funds are traded only once a day, and they’re purchased and sold through the funds that offer them.
  • Trading mutual funds allows you to get professional investment assistance and reduce your risk, but it also has a number of disadvantages, such as high expense ratios and tax inefficiency.
  • Common types of mutual funds include equity funds, bond funds, money market funds, and balanced funds.
  • To trade mutual funds, you have to be prepared to pay a variety of fees and charges, such as transaction fees, purchase fees, account fees, and short-term redemption fees.

What Is Mutual Fund Trading?

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Trading a mutual fund is the act of investing in a company that receives funds from multiple investors and pools them together into one big pot. There’s a professional manager who oversees the fund and invests the money in certain types of assets, such as stocks, commodities, bonds, and even real estate properties. The investors purchase shares in the mutual fund and gain an ownership interest in the assets that belong to the fund.

Designed for longer-term investors, mutual funds aren’t suitable for frequent trading because of their fee structures.

When Do Mutual Funds Trade?

S hares of a mutual fund trade only once a day. The time for trading is after the stock market closes at 4 p.m. Eastern time (ET). If you purchase or sell mutual fund shares, your trade will be carried out at the time when the next net asset value (NAV) is available. The NAV will be calculated after the market is closed and usually displayed by 6 p.m. ET.

Where Do Mutual Funds Trade?

While stocks and ETFs are traded on a stock exchange, mutual funds are bought or sold through the companies that offer them. With the availability of online mutual fund companies, you can now trade mutual funds from the comfort of your own home.

Advantages and Disadvantages of Mutual Fund Trading

While they offer many benefits, mutual funds also have a number of drawbacks. Carefully weigh the pros and cons of mutual fund trading to determine if it’s suitable for you.

Advantages

  • Advanced portfolio management: When you invest in a mutual fund, you’re required to pay a management fee. This fee is used to hire a fund manager to trade stocks, bonds, and other financial instruments on your behalf. This relatively small cost gives you access to expert assistance in the management of your investment portfolio.
  • Risk mitigation: Mutual funds are designed to reduce your investment risk through diversification. In most cases, they invest in dozens to hundreds of different securities.
  • Dividend reinvestment: After they’re declared for the mutual fund, dividends and other interest incomes can be used to buy more shares in the fund. This can help you grow your investment.
  • Fair pricing and convenience: The great thing about mutual funds is that they’re easy to understand and trade. They generally require a low minimum investment, which can sometimes be as little as $2,500. Additionally, since mutual fund trade only once daily, you don’t have to worry about the share price fluctuating throughout the day.

Disadvantages

  • High expense ratios and sales charges: Expense ratios and sales charges for mutual funds can easily get out of hand if you don’t pay enough attention to them. You should be very careful when investing in mutual funds with expense ratios that exceed 1.2% because they’re regarded as more expensive. There are a number of good mutual fund companies that have no sales charges, so you may want to consider investing with one of them.
  • Capital gains tax: When your mutual fund company makes capital gains distributions after selling individual holdings, you’ll be taxed even if you didn’t sell your shares. If the company has a high turnover rate or sells holdings frequently, it may distribute gains on an annual basis.
  • No control over your portfolio: In mutual fund trading, you’re required to entirely give up control of your investment to the fund manager. You can’t decide which stock to buy and how long you want to hold it.

Types of Mutual Funds

There are several types of mutual funds to suit the needs and goals of different investors, including:

  • Equity funds: Equity funds purchase the shares of a number of publicly-traded companies. More often than not, mutual funds are some form of equity funds. These funds are popular because of their high potential for growth, but they may be more volatile in terms of value. According to investment experts, young investors should have more equity funds in their portfolios because they have the time needed to weather the fluctuations in market value.
  • Bond funds: Bond funds are the second most common type of mutual funds and the most popular type of fixed-income mutual funds. If you invest in bond funds, you’ll get a fixed amount back on your initial investment. Instead of trading stocks, bond funds invest in corporate and government debt. They may not have as much potential for growth as equity funds, but they’re a safer option. They’re suitable for older investors who want to increase their incomes without jeopardizing their nest eggs.
  • Money market funds: These fixed-income mutual funds invest in short-term debt from corporations, banks, and governments. Some examples of assets that these funds hold include United States Treasury securities and certificates of deposit. Money market funds are regarded as one of the safest types of investments.
  • Balanced funds: Also referred to as asset allocation funds, balanced funds combine equity funds and fixed-income funds with a specific ratio of investments, such as 55% stocks and 45% bonds. They also come in the form of target-date funds, which automatically changes the ratio of investments to suit your changing investment needs over time.

How Are Mutual Funds Traded?

Since mutual funds don’t trade on the open markets, you won’t be able to transfer your shares to another individual through a broker if you want to sell them. Rather, you have to redeem your shares and then sell them back to the fund itself. You have the right to sell your shares back to the fund anytime you want. After you’ve redeemed your shares, the fund is generally required to reimburse you within seven days, but there are some exceptions to this rule.

While funds have to redeem shares according to your request, this doesn’t mean they can’t impose fines based on certain redemption practices. Usually, you’ll be charged early redemption fees if you decide to redeem your shares within 30 days of purchase.

Types of Mutual Fund Fees and Charges

When you trade mutual funds, you may be required to pay a variety of fees or charges. In some cases, you have to pay a sales charge or load to purchase or sell shares, which is something like paying a commission. Other than loads, you may also be subject to other fees, including:

  • Short-term redemption fees: The purpose of short-term redemption fees is to cover costs that result from short-term trading of mutual fund shares. Typically, they vary from 0.5% to 2% of the trade and usually apply to shares held for less than 30 days to 180 days.
  • Short-term trading fees: Certain no-transaction-fee funds charge a short-term trading fee if you exchange or sell your shares within 60 days of purchasing them.
  • Transaction fees: For some no-load mutual funds, you’ll have to pay a transaction fee on share purchases. The amount you need to pay depends on whether you trade online or through a representative.
  • Purchase fees: These fees aren’t the same as sales loads because they’re paid to the fund itself and not the broker.
  • Exchange fees: In some cases, funds charge a fee if you transfer your shares to another fund that belongs to the same family of funds.
  • Account fees: These fees are imposed to cover the costs incurred in maintaining your account. Typically, you have to pay an account fee if the dollar value of your account falls below a specific threshold.

If you want to succeed in mutual fund trading, you need to do your homework. In some ways, this seems to be a lot easier than focusing on trading individual securities, but you have to do research on other areas as well. Overall, there are many good reasons to invest in mutual funds, and a bit of due diligence can help you take full advantage of this great investment tool to increase your earnings.