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Collectively, mutual funds own about 20% of the stock market. That's more than pension funds, more than government retirement funds and more than international investors. This fact leaves many potential investors wondering how to invest in mutual funds.
Mutual funds are investment behemoths, purchasing specialized sectors and indexes, as well as acquiring shares across a broad market spectrum.
Mutual funds purchase bonds and other securities, sometimes mixing investment types within one fund. A recent study of mutual fund investors showed a median household asset value of $200,000 among mutual fund owners, with most of those investors holding more than half of their financial assets in mutual funds.
More than one-third of mutual fund investors purchased their first mutual fund through an employer-sponsored retirement plan, such as a 401(k).
What is a Mutual Fund?
You can think of a mutual fund as a pooled investment.
A mutual fund combines your investment with those of other investors to purchase a collection of stocks, bonds or other tradable securities. This collection of securities purchased by the mutual fund is called a portfolio. Mutual fund investors own shares in the fund as opposed to directly owning the securities purchased by the fund.
The price of these mutual fund shares fluctuates daily based on the value of the securities held within the mutual fund’s portfolio.
Mutual funds provide an easy way to enter the world of stock market investing, as well as access to other types of investments that are held by mutual funds, such as bonds, and provide access to markets not readily available to individual investors. Investing in individual stocks or bonds requires a thorough understanding of valuations and a keen sense of relevant market changes.
Mutual funds promise to do all or most of that heavy lifting and thinking for you, as many mutual funds are actively managed by investment experts who choose which securities to purchase and sell and when.
The convenience of having someone else manage investment strategy and timing — as well as providing access to markets in which individual investing may be difficult — does come at a price. Mutual funds include various fees and structures that can prevent the performance of a mutual fund from mirroring the investment performance of the securities held within the fund.
Management fees and expenses in a mutual fund take small bites — or sometimes not-so-small bites — out of your investment, which can add up over time.
Types of Mutual Funds to Invest in
Let's take a deep dive into the types of mutual funds you can invest in to help guide your investment decisions.
Closed-end Mutual Funds
Where many mutual funds can issue new shares, a closed-end fund issues a fixed number of shares that are then traded on the open stock market.
Hundreds of closed-end mutual funds are available for trading on the U.S. stock market, spanning common investments like stocks and bonds but sometimes specializing in certain commodities. Closed-end mutual funds are actively managed, with fees sometimes higher than with other types of mutual funds because of a limited amount of shares. In many cases, these fees are priced into the trading value of the mutual fund shares.
Open-end Mutual Funds
Most mutual funds are open-end funds, which means that the fund can issue new shares as needed, allowing a larger pool of investors to participate in the fund.
When a fund’s investment management team or investment manager determines that a fund might no longer meet its stated investment objective if it continues to grow larger, that fund can be closed to new investors. In some cases, the fund can be closed to new investments from existing fund investors.
Open-end mutual funds usually provide more liquidity than some smaller closed-end mutual funds but may provide a smaller potential for gains. Because of liquidity risk for closed-end funds and its effect on pricing volatility, open-end funds are generally considered to be safer than closed-end funds.
Load vs. No-load Mutual Funds
Among the more mysterious terms used in mutual fund investing are load funds and no-load funds.
A load is a fee that is charged either on the purchase of mutual fund shares or on the sale of mutual fund shares. A load charge on the purchase of mutual fund shares is a front-end load, while a load charge on the sale of mutual fund shares is called a back-end load. This is sometimes referred to as a contingent deferred sales charge (CDSC).
Many funds do not charge a load, and these are called no-load funds.
Vanguard, one of the largest mutual fund providers and investment companies in the market, built its name in large part on no-load funds. One of its well-known investment products, the Vanguard 500 index, is now in its fifth decade of trading. For load funds, the load is charged in addition to annual expenses and management fees and is usually divided between the mutual fund company, the brokerage and the individual broker who sold the fund to the client.
In that regard, it's similar to the commission you might pay when selling a house. The load is a sales charge that helps to compensate your investment adviser. If you're purchasing a mutual fund without the help of a broker or adviser, a no-load fund may be a better value because it doesn't pay a commission for research you did on your own.
Check out Benzinga's picks for the best no-load mutual funds.
How to Choose Mutual Funds to Invest in
In many cases, mutual fund investors choose their fund based on the recommendation of an investment adviser or because they're familiar with the name of the company sponsoring the fund. Some popular mutual funds you can invest in are equity fund, bond fund, money market fund and stock funds.
In the case of a 401(k), your mutual fund choices are often sorted according to your preferred risk level or by expected performance versus the broad market. In both of these cases, your choice may be simplified, without much discussion of the fees and expenses that can affect the long-term performance of your investment.
The various types of funds may not be discussed in detail if using a broker recommendation or investing through a 401(k) or an IRA. If you’ll be purchasing mutual funds on your own, there are some industry-specific terms you'll need to understand.
How to Start Investing in Mutual Funds
Mutual funds can be purchased through a broker, either online or locally if you prefer a brick-and-mortar business. To begin investing in mutual funds, follow these simple steps.
1. Decide if You Want to Go Active or Passive
When investing in mutual funds, you have two primary options: active or passive. Each has its own set of advantages and disadvantages, so it’s important to understand the differences between them before deciding which is right for you.
2. Create Your Budget
Creating a budget is an important step in the process of investing in mutual funds. By creating a budget, you can determine how much money you have to invest and track your progress as you work toward reaching your financial goals. Here are some tips to help you get started on creating a budget:
- Make a list of all of your monthly income and expenses: This includes wages, investments, and any other sources of income.
- Subtract your expenses: Subtract your expenses from your income to determine how much money you have available for investing.
- Determine your monthly expenses: Determine how much you can realistically afford to invest each month. This should be an amount that fits within your budget and still allows you to cover all of your necessary expenses.
- Set goals for yourself and track your progress: Goals can be short-term or long-term and you should adjust them as needed to reflect your financial situation.
- Research Your Options: Once you’ve created a budget for yourself, it’s time to start researching different mutual funds that fit within that budget. You’ll want to consider factors such as fees, performance, and your investing goals when evaluating different funds.
3. Choose Your Broker
When you invest in mutual funds, a key decision is choosing where you want to open a brokerage account. Your broker is the entity that will execute your investment orders and provide you with various services related to investing, such as research on funds and portfolio management advice. There are several types of brokers available for mutual fund investments including discount brokers, full-service brokers, and fee-based advisors.
4. Understand the Associated Fees
While mutual funds offer the potential for higher returns than a savings account, the fees can take a bite out of your profits. It’s important to understand all of the fees before you commit to a particular fund. The most common fees associated with mutual funds include sales charges, expense ratios, and redemption fees.
5. Manage Your Investments
Managing your investments is essential to achieving financial success and security. Investing in mutual funds is a great way to diversify your portfolio, but it's important to understand how to manage your investments effectively. It is important to review your investments regularly to make sure they're still meeting your goals. If not, consider making adjustments in order to keep your portfolio balanced and aligned with your objectives.
Best Brokers for Investing in Mutual Funds
With any online broker, you'll want to open an investment account with a broker that has low commissions, an easy-to-use platform and great customer service. Check out Benzinga’s top picks below.
Things to Consider When Investing in Mutual Funds
As you're gearing up to invest in mutual funds, here are a few factors to take into consideration.
Index Funds vs. Actively Managed Funds
Mutual funds can be actively managed, leveraging the market insight and investment acumen of a management team, or they can take a simpler form that largely tracks an index.
Choosing between the two types of funds, actively managed versus passive, is a matter of preference, depending on your investment goals and your comfort level either in the ability of the fund manager or in the longer-term trend of a market index. On paper, you can find advantages and disadvantages for each type of fund.
Historically, broad market indexes have provided higher returns than most actively managed mutual funds.
There are, of course, exceptions. A handful of actively managed mutual funds have beaten the S&P 500 index for the past 10 years. However, many of these funds are closed to new investors. Expense ratios, loads and trade timing can affect the overall performance of an actively managed fund. On the other hand, an actively managed fund might help to protect your downside because fund managers aren't paid to lose money.
This setup creates an incentive to reduce holdings in underperforming securities, either moving assets to cash temporarily or reinvesting in other opportunities.
Owning shares in an index fund, which is not an actively managed fund, can mean that during prolonged market corrections or crashes, the value of your fund shares can fall dramatically because the fund tracks a given index within the market. If the index goes down, so does the value of the shares held in the mutual fund.
The modern mutual fund market provides something for everyone from niche funds to broad index funds to specialized index funds and actively managed funds.
Some segments or funds tend to be more volatile than others. If you're a young investor, volatility isn't necessarily a bad thing, provided the overall trend is upward. In the long run, markets tend to recover and prosper. If the value of a mutual fund drops too far, the mutual fund company might choose to dissolve the fund or transfer the assets of the poorly-performing fund to a larger fund.
Mutual funds, because they tend to be well-diversified or follow a market index, are unlikely to go to zero as an individual stock can. If you're closer to retirement age, volatility might not be as kind to the value of your mutual fund shares, which is an important consideration if you might need to access the value of your mutual fund investments in the near future.
When researching historical returns for a mutual fund, the headline numbers for recent returns can be a distraction.
Returns for a short time period, whether positive or negative, can be an aberration or a possible indication of volatility. A well-established fund will be able to demonstrate returns over a longer time period of five to 10 years or longer, helping to guide your decision based on long-term performance. As you'll commonly see in industry advertising, past performance does not guarantee future performance.
Every fund can have a great, bad or mediocre year, and management teams responsible for past successes can change, making past performance statistics a tool that you can use to help you choose a fund but not a guarantee.
Benefits of Mutual Fund Investments
Mutual fund investing is generally considered to be a safer way to invest in the stock market or bond market or to gain trading exposure to other types of securities than investing directly in these markets.
In many ways, mutual funds simplify investing by tracking a broad index or a smaller index or by providing active management by investment experts. The average investor is often too busy with work, family and other responsibilities to watch markets closely and to keep tabs on industry or company-specific changes that can affect the value of investments.
This is what fund managers do, which can provide value.
Additionally, mutual funds provide diversification. Many individual stock investors have suffered losses because investments were heavily weighted in a specific sector or an individual company. It's possible for individual investors to invest a dollar and get back 50 cents. Because mutual funds are usually more diversified — and actively managed in some cases — that type of loss is less likely.
Another benefit of mutual fund investing is access to markets or individual securities to which you may not have easy access as an individual investor.
Because you are buying shares in the mutual fund as opposed to shares in the underlying equities or buying other securities that the mutual fund holds, you can buy small pieces of companies. For example, through mutual fund investing you can gain investment exposure to stocks like Google, over $1,000 per share in June 2023, which might be more difficult to purchase individually because of its higher-than-average share price.
Invest in Your Future
Investing in mutual funds can be a great way to help you reach your long-term financial goals. By understanding the different types of mutual funds, the risks associated with them, and how they work, you can make an informed decision about which one is right for your particular investment objectives.
It’s also important to remember that past performance is not indicative of future results, you should actively monitor and adjust your investments when necessary. With a little bit of knowledge and careful planning, investing in mutual funds can be an effective way to reach your financial goals.
Frequently Asked Questions
Why invest in mutual funds?
Investing in mutual funds can be a smart way to diversify your portfolio and reduce risk. They pool money from multiple investors and invest in a variety of assets managed by investment professionals to maximize returns and minimize losses. This process can lead to more consistent returns over time and help grow your wealth in the long term.
How are mutual funds taxed?
Mutual funds are taxed differently based on the type of income they generate, such as capital gains, dividends and interest income. Investors may be subject to taxes on gains from selling shares; consult a tax professional for guidance.
Should I invest in a mutual fund?
Investing in a mutual fund is one option for investing and may or may not be the right fit for you depending on your goals, financial situation and risk tolerance. It’s best to consult with a financial adviser if you’re unsure about which type of investment is best for you.
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