Top 6 Things You Need to Know About Mutual Funds

When it comes to investing in the market, there is a whole world of options. One of these options is to invest in mutual funds, which is a common investment choice. It involves investing in many diversified securities as part of a portfolio. Learn more about mutual funds and how they work so you can determine if they are the best choice for you.

  • Mutual funds are those that have pooled together money from investors to invest in securities such as stocks and bonds.
  • The price of a mutual fund is also referred to as its Net Asset Value.
  • Mutual funds are advantageous for the convenience, liquidity, management, and diversification they offer.

What Are Mutual Funds?

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Mutual funds are a type of investment that many new and seasoned investors take part in. It involves pooling your money along with the money from other investors and purchasing a portfolio of stocks, bonds, and other securities. A portfolio manager manages the fund. Mutual funds are a popular choice for many because you then have access to a broad range of investments you don’t have to manage yourself and don’t have to purchase individually, which can be more complicated.

You may be a part of a mutual fund and not even realize it. It’s common to own mutual funds as part of a contribution retirement plan, such as an Individual Retirement Account (IRA) or employer-sponsored 401(k).

Each mutual fund has an investment objective that drives how the portfolio manager acts in the interest of the fund, including the types of securities the fund invests in. For example, one mutual fund may have an objective to generate income for shareholders while another may be most interested in capital appreciation. [BUBBLE QUOTE] The portfolio manager is responsible for investing in a way that will help the mutual fund achieve its objective.

How Mutual Fund Pricing Is Determined

A mutual fund’s pricing is also referred to as its Net Asset Value (NAV), which is calculated by taking the total value of the securities in the mutual fund’s portfolio and dividing by the number of current shares that have been claimed by investors. The mutual fund may have a different NAV at the end of each trading day based on the value of the securities over the course of the day.

Most mutual funds have a purchase minimum, but it’s common to find mutual funds whose minimums are very realistic for many. For example, a mutual fund’s individual purchase minimum may be $150 per share, while another’s may be $3,000 per share.

Fees Associated With Mutual Funds

There are typically fees associated with mutual funds, but as long as you know what to expect, you should be able to go into a mutual fund and not be surprised by future or immediate fees that you’re responsible for. Some examples include:

  • Expense ratio: This is the most common fee associated with mutual funds, and many investors look at the expense ratio of the mutual funds they’re interested in before deciding which to go with. An expense ratio is an annual fee that shareholders are responsible for. The expense ratio is basically the operating costs for the fund, including administrative, distribution, and marketing fees, and is deducted each year from the fund to cover this cost.
  • Sales charge or sales load: Unlike the expense ratio, this fee is a one-time charge. You will pay either a front-end sales load when you buy the fund or a back-end sales load when you eventually sell the fund. However, there are no-load mutual funds that you can purchase and avoid this charge.
  • 12b-1 Fees: These fees are less common, and many investors choose not to invest in mutual funds that have this expense. A 12b-1 fee is an ongoing fee that a firm or advisor charges for marketing the fund.

Common Types of Mutual Funds

These are some of the most common types of mutual funds:

  • Bond or fixed-Income: As the name implies, bond funds are those that invest in bonds alone. They are also called fixed-income funds because you can expect that you’ll receive a reliable rate of return, but because you’re extending your money with the hopes of eventually getting it back, there is some risk involved.
  • Stock or equity: With this fund, you’re investing in company stocks. Some equity stocks pay a dividend while others don’t.
  • Money market: Money market funds are generally low risk because you’re only investing in high-quality investments over a shorter term. These investments are issued by established corporations and governments, but they don’t tend to grow fast.
  • Balanced: Balanced funds invest in both stocks and bonds, usually at a 60% stocks to 40% bonds ratio, although this can vary. The balance of stocks to bonds in a particular mutual fund doesn’t change.
  • Sector: Sector funds are ones that invest only in a specific sector, such as technology.

Advantages and Risks of Mutual Funds

Before deciding if mutual funds are the best investment choice for you, take a look at the associated advantages and risks of mutual funds:

Advantages of Mutual Funds

The advantages of mutual funds include:

  • Diversification: Many experts would say that diversifying your investment portfolio is an excellent choice because it typically carries less risk. When you invest in a mutual fund, you usually have hundreds and sometimes thousands of securities as part of the portfolio, which means if one of the securities fails, you can likely recover just fine.
  • LiquidityThere are some investments that require a certain amount of time to go by or penalties to be paid before you can access your investment, but it’s different with mutual funds. You can both buy and sell mutual funds at any time for the current NAV minus any fees. This means that you have access to your investment dollars whenever you want them.
  • Convenience: It’s possible to buy and sell mutual funds in many ways, including by phone or online. Plus, you can set up automatic investments and even withdrawals.
  • Professional management: A professional will manage your mutual fund portfolio, making it something you don’t have to worry about until you’re ready to buy more shares or sell some of the ones you currently have. A professional will operate with the mutual fund’s objective in mind.

Risks of Mutual Funds

As with any investment, there are risks with mutual funds. If one or more of your securities plummet, you can lose your investment in that security. However, that’s exactly why diversification can help.

Mutual Fund Payments

During the time you’re invested with a mutual fund, you may receive payments in the form of dividend payments or a capital gains distribution. Dividend payments occur when your fund has earned an income from stock dividends or bond interest. The fund then pays all of that income, minus any expenses, to the shareholders. When a security has increased in value and the fund sells that security for a profit, that’s called a capital gain. If there is a capital gain at the end of the year, the mutual fund will pay these capital gains to the investors.

These two forms of payment happen automatically, but investors can always withdraw their investment plus any earnings they’ve received at any time. A higher NAV means the investment is higher, so investors can choose when the right time is to request to sell their investment.

How To Choose a Mutual Fund

While the process of choosing a mutual fund may look different for each individual, it’s important to determine goals and how much risk you’re willing to take on. Those investors who are on a timeline to make the most of their investments may choose a different course than someone who would rather grow their investments in a more slow and steady manner.

When looking at different mutual funds, it’s essential to also evaluate the portfolio manager to make sure they have proven success in generating returns for the investors they represent. Investors can also view a fund’s long-term performance to see how the fund has changed over time. While investors can certainly judge a mutual fund by the most recent year, looking at the fund history over several years will give investors a more clear idea of how the fund naturally ebbs and flows.

Once you’ve chosen a mutual fund, you can either buy per share or with a certain dollar amount. For example, an investor may choose to buy 200 shares of the company and pay for that investment according to the price per share, or they may put forth $2,500 and receive however many shares that equates to. Mutual funds can also distribute shares in fractions, so investors don’t have to purchase whole shares of a fund.

Now that you know a little bit more about mutual funds, it’s time to get started with some inspiration and knowledge on how to make it in the market.