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The key to successful investing is a diversified portfolio. And one of the simplest ways to diversify your portfolio is through mutual fund investing.
Mutual funds are companies that pool together money from multiple investors to buy stocks, bonds, and other assets.
This form of investing may offer many benefits to investors, but if you're new to mutual fund investing, it's important to understand the basics of what they are, how they work, and how to get started.
Mutual Funds Explained
Mutual funds are professionally managed portfolios that expose shareholders to multiple assets.
They may contain stocks from numerous companies so investors who invest in a mutual fund are essentially purchasing parts of each of those companies.
Mutual fund investing is appealing to investors because it allows them to spread their capital among several assets rather than one stock or bond. Even if one of the assets in the fund decreases in value, the value of the entire fund is expected to increase over time.
Additionally, mutual funds benefit from professional portfolio management, in which an investor's money is allocated based on the portfolio manager's expertise. While investors pay a fee for this service, it also gives many investors peace of mind knowing their investments are being handled by a professional.
Investors choose mutual funds based on the goals of the fund and the index it follows. Each fund has its own investment strategy. Some funds seek to maximize the amount of income for their shareholders or act as a mutual fund for monthly income. Meanwhile, others focus on
long-term bonds, capital appreciation, angel investing, and more.
Funds can be managed passively or actively. Actively managed funds are handled by a portfolio manager who buys and sells stocks in an attempt to outperform the market or another set standard. Passively managed funds simply involve purchasing a portfolio that tracks an index.
It's important to note that exchange traded funds (ETFs) are often associated with mutual funds but there are differences. While ETFs are considered a pooled, passively managed investment, they are traded throughout the day and focus more on market indexes. They are actively traded during each trading day, while mutual fund trades only close once the trading day is over.
For anyone considering mutual fund investing, the first step is to consider what your goals are is to align yourself the indices you want your fund to follow. You should also think about how long you want your money tied up in the mutual fund.
Monthly dividend mutual funds can also be a reliable source of regular income. But some longer-term funds may charge sales fees and you will want to maximize your returns before paying the fee.
What Types of Mutual Funds Are There?
The world of mutual funds presents several options and that can seem overwhelming for novice investors. A quick overview of the different types of mutual funds will help provide a better understanding of where to begin.
Index funds track the performance of a specific index-for example, the S&P. The value of the mutual fund follows the index. These funds tend to be less expensive because it involves less effort on the part of the money manager.
Fixed-income mutual funds buy investments such as government or corporate bonds which offer a fixed return. Money earned from the bonds' interest supplies a steady stream of income.
High-yield mutual funds in this category bring bigger risk because they involve bonds from corporations considered less likely to be able to pay the loan back.
Equity funds are a form of mutual fund investing that holds stocks. There are several different types of equity funds, including:
- Income funds: These funds collect stocks that are known to pay steady dividends.
- Growth stocks: Stocks that usually don't pay dividends but are expected to expand their business.
- Market sector funds: Funds that focus on a specific sector of the business world, such as pharmaceutical, technology, or energy.
- Index funds: Funds that follow a specific exchange, such as NASDAQ or NYSE.
- Capital appreciation: Income mutual funds that choose stocks for the portfolio based on the idea that their price will rise.
These are just a few of the options when it comes to mutual fund investing, but it's helpful to know that index funds are the most popular with nearly 10,000 available.
Money Market Funds
Money market funds invest in stable, short-term, fixed-income assets including government bonds, certificates of deposit, treasury bills, and more. Because these investments may be less risky than some, there is generally less of a return than growth and income mutual funds.
Dividend Mutual Funds
As the name suggests, dividend mutual funds invest in stocks that pay dividends. Shareholders are given the option to reinvest the dividends for more shares in the fund or to take profits.
High-dividend mutual funds help mitigate risk in a portfolio, in case the stock market takes a downturn. Mutual funds that pay monthly dividends offer a steady stream of capital in addition to whatever profits are made off increasing stock value.
Balanced funds give shareholders exposure to both fixed-income securities and equities. The point is to balance some higher-risk stocks with bonds that have a fixed return.
More aggressive funds tend to lean towards stocks, while conservative funds focus more on bonds.
Should I Invest in Mutual Funds?
Below are three of the main benefits of mutual fund investing:
Low Minimum Investments
Most mutual funds have minimum requirements to invest but several are quite affordable, averaging between $1,000 and $3,000. Many employer retirement plans, such as a 401(k), have no minimum investment requirement.
As an investor in individual stocks, you only have the opportunity to research and evaluate a limited amount of stocks. With mutual fund investing, you are exposed to hundreds-and maybe even thousands-of stocks.
Every share bought in the mutual fund gives you a proportional share of all of its underlying assets.
You can spend a lot of time studying charts and researching companies, but that can be quite time-consuming. With mutual funds, you have a professional money manager whose job is to pick successful assets that work on your behalf.
Getting Started in Mutual fund investing
Now that you've decided to invest in mutual funds, you need to strategize. The first step is to determine your budget and the amount of risk you are willing to take.
Once that is settled, it's time to decide between passive or active strategy. A passive strategy assumes less risk and may average better ROI, but active strategies may offer bigger returns in the short term.
Mutual fund investing is filled with decisions, and one of the most important you will make is where to get your mutual funds. You can choose to use an online platform like E*TRADE or Merrill Edge or go through a broker. Either way, you need to consider: the cost and minimum investments, available funds, and how much access you have to learn about the investments.
In addition to the minimum cost, it is important to be aware of the fees the mutual fund charges. In addition to the aforementioned sale fee for selling your shares, you could face account fees, shareholder fees, operating expenses, and more.
Lastly, it's important to look at the history of the mutual fund and how it has performed over the years. A long-term view of the fund will give you an idea of what you can expect from its future trajectory.
It's helpful to look at reviews and ratings (from resources like Morningstar) to assess different portfolio management teams and better understand how they align with your financial goals, investment strategy, and what fees they charge.
Mutual fund investing is an important part of any portfolio. Before you set off on your journey into the world of mutual funds, keep in mind:
- Mutual funds sell investors shares in different funds, which purchase a variety of assets.
- There are several types of mutual funds including equity funds, index funds, money market funds, fixed-income funds, and more.
- Mutual funds can be managed actively or passively.
- Benefits of mutual funds include portfolio diversification, low minimum investments, and a professionally managed investment strategy.
- When starting with mutual fund investing, it is important to strategize, evaluate brokers in terms of fees, funds available, and history.
The diversity presented by mutual funds makes it a perfect addition to retirement funds and savings. For more tips, read our complete guide to income investing for retirement.