Everything You Need To Know About Mutual Funds
/Buying shares of a mutual fund is a well-diversified, cost-effective, and tax-efficient way of making your savings grow. Mutual funds are an easy investment option for those who do not have the time and expertise to invest directly in stocks. With mutual funds, you simply invest in a fund, and the fund manager will then pick the best stocks that will produce good returns over time.
If you have a workplace or self-employed retirement savings account, like a 401(k) plan or a Roth IRA, then the easiest way to start investing in mutual funds is through your retirement savings account.
If you are new to investing or want to invest in mutual funds, then here is everything you need to know about mutual funds.
What are Mutual Funds?
Like ETFs, mutual funds are baskets of securities, such as bonds, securities, commodities, etc. A mutual fund pools money from several investors. Each investor then owns units or shares of the fund proportionately based on their share. The money held in a mutual fund is managed by a fund manager who manages the fund and chooses investment options to produce capital gains or income for the fund's investors.
Mutual funds are regulated by the Securities and Exchange Commission (SEC) and managed by professional fund managers based on the specified investment strategy and goals set by the investors.
Mutual funds offer investors easy access to professionally managed investment portfolios of different securities such as stocks, bonds, commodities, currencies, and other securities without the need to research literally thousands of companies and investment instruments.
If you are new to investing and do not know where to invest, then mutual funds can be a great way to invest in stock markets without the need to research literally thousands of companies and investment instruments.
How do I invest in mutual funds?
Most people invest in mutual funds through their employer-sponsored retirement savings accounts. You can invest in several kinds of mutual funds through your employer-sponsored retirement account, like a 401(k) plan or a Roth IRA. Your employer may match the funds you invest.
You may invest in mutual funds through your retirement savings account, brokerage firms, online investment firms, directly the fund companies, or even through apps. You can open a mutual fund account with as little as $5 or up to $3,000, depending on the account provider you choose.
When you are ready to start investing in a mutual fund, it is important to check what kind of risks it takes, how it has performed historically over five years or 10 years, and who is managing the fund.
How mutual funds work
When you buy some shares in a mutual fund, you are buying ownership of the mutual fund and the assets held by it proportionately based on your shares. It is important to note that investors in mutual funds do not own the securities in which they invest money; they only own shares in the fund itself.
The price of a share in a mutual fund is known as the net asset value (NAV) per share. It is determined by the total value of the securities held in the fund, divided by the number of the fund's outstanding shares. The price of a mutual fund share fluctuates based on the value of the securities held in the fund each business day at the end of each trading day.
When you invest in a mutual fund, you cannot invest in individual companies such as Apple or Amazon. Instead, you will invest in shares of a mutual fund, which represent a variety of securities, like stocks, bonds, commodities, etc. held by the mutual fund. You can invest in a company like Apple or Microsoft by investing in a mutual fund that holds shares of those companies.
Some mutual funds contain just one type of investment, like bonds or shares, while others contain a mix of different securities such as stocks, bonds, etc., or hold a specific market or region, like the emerging stock markets, the UK, Europe, or Asia.
Investors in a mutual fund typically earn a return from dividends on stocks and interests on bonds held in the fund, capital gains if the fund sells securities that have increased in price, and shares that you sell for a profit when the fund holdings increase in price.
Different types of bond funds
There are different kinds of mutual funds. Here is a brief rundown:
Stock funds
When it comes to mutual funds, most of the time people refer to stock funds. When the fund managers purchase corporate stocks, these are stock funds.
There are a number of different kinds of stock funds such as growth funds, income funds, index funds and sector funds. Growth funds invest in stocks that have a potential for higher financial returns.
Income funds invest in stocks that pay a good dividend. Index funds purchase shares of all the companies in a particular market such as S&P 500 so your returns will match closely to the broader market. Sector funds purchase shares of specific industries.
Target date funds
Target date funds hold a mix of securities, such as stocks, bonds and other kinds of investments, like short-term debt notes. The goal of a fund manager of a target date mutual fund is to combine these different kinds of investments to match your expected retirement date. You can take more risk with a target date mutual fund if you have more time until retirement. But, as you get closer to retirement, these mutual funds tend to invest more in bonds which are more stable than stocks, so you will end up owning a larger percentage of bonds.
Bond funds
Bond funds are considered a safer investment, as they are more stable than other types of mutual funds. You can invest in a variety of bonds, such as government, corporate, municipal, and short-term notes. They can also include mortgage-backed securities.
Money market funds
Money market funds focus on short-term debt guaranteed by commercial banks, certificates of deposits, corporate debt, government securities, and U.S. Treasurys.
Mutual fund fees
Investing in mutual funds can incur three types of fees: operating expenses, sales commissions or loads, and transaction or trading fees. Your fund company can charge an annual fee, known as Operating Expense Ratio (OER). How much you pay depends upon the fund itself.
You will be charged sales commissions when you buy and sell your mutual fund shares.
Your brokerage company may charge you a trade fee when you purchase or sell a mutual fund. When you buy a mutual fund, your brokerage company may charge commissions known as an initial sales charge or front-end load, or you may be charged commissions, known as a deferred sales charge or back-end load when you sell a mutual fund.
Why should you invest in mutual funds?
Mutual funds offer diversification to your portfolio. When you invest in a diversified mutual fund that holds assets across classes, regions, sectors, or industries, it lowers your investment risk while potentially increasing your returns on investments.
Mutual funds are professionally managed by world-class expert fund managers who have the expertise to research companies and pick the best investments for the investors. If you do not have the time or expertise to research companies and see where to invest, investing in mutual funds can be the best investment option for you.
Most mutual funds are liquid. If you cash out your mutual fund, you can have your money back in your bank account within just a few days.
You can buy or sell your fund shares once a day at the close of the market at the fund's NAV. Your income from dividends and capital gain distributions can also be reinvested automatically. You can also make additional investments at any time.
You can choose from literally thousands of mutual funds available to investors to invest in a mutual fund, based on your risk tolerance, expected returns, and investment objectives.
How to determine the best mutual fund to invest in?
Since everyone is unique, the best mutual fund to invest in will vary depending on each individual's financial circumstances and goals. You should select a fund that better suits your financial needs.
When it comes to investing in mutual funds, look for funds that fit your savings goals or risk level. If you are looking to invest for retirement, then you will want to invest in mutual funds that contain more bonds and money market investments. Bonds offer lower returns over time, but they are more stable.
If you are interested in impact investing, you will want to invest in a mutual fund that aligns with your values and concerns then look for ESG funds that align with your values.
If you are looking to grow your assets aggressively or quickly, then you will want to invest in growth funds.
Risks of investing in mutual funds
Like every other investment option, investing in mutual funds comes with risks. These include market volatility risk, liquidity risk, foreign exchange risk, interest rate risk, and many others.
It is important to note that every investment involves risk. You should always consult a financial professional before investing in mutual funds. Before you invest in mutual funds, it is always a good idea to understand how much risk you can handle.
If you want to invest in mutual funds, then invest in bond and money market funds, as these are safer than other kinds of mutual funds. But if you want to make as much as possible, you may want to invest heavily into growth funds.
In conclusion
If you are new to investing and do not have the time or energy to choose between millions of investments available out there, then you can consider investing in mutual funds.
