Mutual funds are a great way to invest in the market with some diversity and only having to choose one fund at a time if you want to.
These funds allow you to invest in dollar amounts, rather than purchasing set share amounts, making it easier to invest your way with fewer limitations to set up investments.
Before you jump in to start investing, there are some things to know and be aware of. There will some information to sort through so you can decide what mutual funds are the right fit for your needs.
What is a Mutual Fund?
A mutual fund is a pool of funds that are all put together to create a single fund that you can invest in. Each fund has a specific focus and may contain a variety of things such as stocks, bonds, short-term debt, and other holdings as well.
These funds are managed in some way and are created by fund companies. Most funds measure against an index for tracking purposes.
There are several different types of mutual funds out there, but they work primarily the same way across the board. You purchase into a fund based on the type of fund you’re interested in and a dollar amount. The fund purchase occurs at the closing of the business days and settles within 2 days, typically.
Types of Mutual Funds
There are different types of mutual funds to choose from.
Most of the categories fall into either common mutual funds or speciality mutual funds. The difference between common and speciality is simply that speciality funds will have unique strategies that invest in things like commodities, while common will use traditional equities, cash, and similar instruments to create.
It's also important to note that there are different funds for different strategies. Those include options such as:
- Income
- Growth
- Aggressive growth
- Growth and Income
- International
Most funds can be placed into these categories in one way or another, based on their strategies. What is the concept behind the fund — the driving factor, if you will. Here is a quick overview of the most popular types of funds to choose from.
Target Date Funds
A target date fund is popular for a set it and forget it type of portfolio. These are used often in retirement accounts, but they can also be used in a personal account that you intend to hold for the long-term.
A target date fund will have a date set for the future, and the investments are selected based on achieving success by those dates. So, if you plan to retire in 2035, you would choose that target date. When you initially buy in, the fund might be focused on growth, but as you get closer to 2035, the fund would move closer to a conservative style and an income focus.
Index Funds
Index funds are a type of mutual fund that specifically invests with the goal of matching or beating a recognizable index. The performance of the fund will be similar to the tracking index in most cases, which make them a popular choice as you don’t have to worry so much about picking the winners. Instead, the fund benchmarks the index and follows it closely.
Money Market Funds
Money market funds are typically very conservative choices. These are used for cash or cash equivalents when in a portfolio.
The holdings in a money market fund will be cash or cash equivalents that make low interest most of the time. This could include things like savings accounts, CDs, treasury bills, and other similar assets. They do often pay slightly higher than a traditional savings account.
Bond Funds
Bond funds are also conservative in nature, unless you choose a low-grade bond fund that is intentionally more aggressive in order to chase higher income.
Bonds funds are one of the most popular choices for mutual funds because they create an income stream while diversifying your portfolio to several different bond holdings. You can determine the type of fund based on the bonds inside of it.
Stock Funds
Stock funds can be designed to accommodate both growth and income. It simply depends on the design of the funds. These funds will hold a variety of equity assets, but may also compile other things into the fund to meet the fund strategy.
Balanced Funds
A balanced fund is a fund that provides you a mixture of assets, balancing it out in the same way you might balance out a portfolio if you handpicked your stocks and assets. These funds will be denoted with specific strategies and the assets within will be reflective of those strategies.
Active Mutual Funds vs. Passive Mutual Funds
One thing to note about mutual funds is the difference between active and passive management.
If you’ve ever compared two funds and wondered why one’s fees are so much higher than another, it’s likely because of the management style.
Mutual funds can be actively managed or passively managed. A passively managed fund will have lower fees because they are not as hands on to maintain.
These funds, like index funds, are designed to benchmark against a certain marker and then created to be similar to that marker. They are occasionally rebalanced and adjusted, but they are not closely monitored or changed frequently.
In an actively managed mutual fund, it’s exactly the opposite. These funds are actively managed and controlled by a highly-trained individual, or by a team devoted to monitoring the fund.
The fund managers are in charge of picking stocks and assets within the fund, but are required to follow the fund strategy as they make picks. Because these funds are closely monitored, they typically have higher returns but also higher fees.
It will be up to you to determine the fund that is the best fit for your portfolio and needs. Choose funds that fit within your preferences and be aware of whether or not they are actively or passively managed as this could affect your overall results.
How to Invest in Mutual Funds
There are several steps to follow as you consider how you want to invest in mutual funds and seek the right fit for your needs. Follow these steps and then check out the tips to help you choose your funds.
1. Know Your Goals
Before you start picking mutual funds, take the time to establish your goals. Do you want to choose active or passive funds, what are your goals? You may even choose more than one mutual fund to diversify your portfolio even further. Consider whether you’re looking for cash-related assets, growth assets, income assets, or something different altogether.
Knowing your goals and your preferences will help you make better choices for the funds that you want to place in your account.
2. Set Up an Account
Before you can invest in mutual funds, you will need a trading platform or a mutual fund account. Some companies that offer their own mutual funds allow you to open accounts directly through them and establish your portfolio. You can choose to use an online broker, or simply work with a mutual fund provider — whatever works for you!
Choose where and how you will be investing in mutual funds and get an account set up if you don’t already have one. Make sure you choose a platform that will have access to a wide variety of mutual funds, or at least the mutual funds that you are most interested in.
Part of your set up will include sharing your financial goals and strategies. This helps your provider get to know your needs and preferences for any recommendations they may provide.
3. Choose Mutual Funds
Now it’s time to choose the mutual funds you like. You can start with just one fund and then add to your portfolio later. You can also diversify now by choosing funds in a few different categories. It’s totally up to you.
You also could choose to be in a robo advisor portfolio, a fully managed portfolio, or a completely self-directed portfolio. These are your preferences and choices. As you choose the funds for your portfolio, consider these things.
- Passive or active funds
- Fund fees
- Minimum investment requirements
- Your strategy
- Financial goals
- Fund history and performance
- Type of fund
These details will help you pick funds that really are geared towards your goals and your needs. Do a little research and find funds that are the right fit. You might also be able to make choices based on popular funds in specific categories.
Tips to Invest in Mutual Funds
Investing in mutual funds is pretty simple, although there are thousands of different fund options to choose from.
A little bit of research will go a long way when you’re selecting funds. Staying with funds that fit into your goals and preferences will also matter.
Take a look at these tips as you set up your mutual fund investments.
Budget
It’s a good idea to determine how much you will invest initially and whether you plan to continue to add to this fund on a regular basis. With mutual funds, you can typically set up automatic investments where a certain dollar amount is purchased monthly, quarterly, or on any basis you determine.
Some funds do have minimum investment requirements so be sure to choose a fund that you can afford to get into. Set your budget with the cost of investment in your mind. You don’t want to pay high fees if you are investing frequently or can only invest a small amount.
As part of your budget, also consider whether your broker will charge you trading fees for your mutual fund purchases as this could directly affect your costs.
Know the Terminology
In the mutual fund world, there are a lot of terms used that you might not recognize. Things like small cap, sector, and even turnover are pretty common here so take some time to understand the lingo to ensure you truly get it.
These are some of the most common terms you may come across.
- Small Cap, Medium Cap, or Large Cap — this term defines what type of capitalization lies within the fund. For example, a large cap fund is going to invest in large companies that are popular and have massive revenues. Small cap funds will invest in smaller companies and may be more risky because of that.
- Performance — the performance is also the rate of return and establishes how much your mutual fund might make. If you look at historical performance, you will want to see consistency, or at least be aware of the roller coaster you may be facing.
- Asset Allocation — this is the allocation of the investments within the funds. Every fund has a strategy and this strategy will determine the percentage that might be cash or other assets within the fund.
- Sectors — a sector is the type of business or investment instrument that will be in the fun. For example, a real estate fund will have real estate investments, REITs, and other similar items.
- Turnover Ratio — the turnover ratio is how often assets within the fund are turned over, which is the buying and selling ratio within the fund. Higher turnover rates usually depict looking for bigger returns.
Mutual Fund Fees
In a mutual fund, there are several different types of fees that you might experience. The fee to be most aware of is the management fee, which is typically referred to as the ongoing fee or the expense ratio. These fees are assigned a percentage, which means you will pay that percentage of the holdings you have of this particular mutual fund.
In addition, there are also load funds or no-load funds and these funds charge their fees for purchase in different ways. A load fund will charge a commission or a trading fee to purchase the fund. This is added to every purchase.
A no load fund will never charge commissions on sales and this is what the majority of mutual funds are. However, they may also have slightly higher expense ratios to compensate for no sales fees.
Final Thoughts
There are mutual funds out there for every trading preference and every investment strategy. As an investor, you have the right to choose what fits your needs the best. Use these tips and steps to help you get into a great fit!
If you plan to invest regularly, be sure to set up automatic investments or set a reminder for yourself to ensure routine investments into your funds of choice are being made. Mutual funds provide a great solution for simple investing, diversity, and creating a portfolio that is designed for your financial goals.
Take the time to do some research and find the right fund fit for your goals. Don’t forget to look at fees, expenses, and the strategy or management of the funds you consider.
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