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Guide to Mutual Funds - Beginners

Updated on August 16, 2014
Image courtesy of [Kittikun Atsawintarangkul] / FreeDigitalPhotos.net
Image courtesy of [Kittikun Atsawintarangkul] / FreeDigitalPhotos.net

What is a mutual fund?

A mutual fund is a type of investment that pools funds taken from individual investors for the purpose of investing in securities such as stocks and bonds. They are managed by a financial professional that works for the company the mutual fund belongs to, and make decisions on how the pooled funds will be invested. Their goal is to make as much return on those funds as possible. There are fees associated with mutual funds: management fees, expense fees, etc.

When assessing your personal finances, checking out mutual funds should be on your list. Mutual funds can be a great addition to your portfolio, and can be bought for very little to no cost at all. There are many mutual funds that are sold through financial institutions such as Charles Schwab and Vanguard that actually have no commission if you buy through those companies.

Mutual Funds Easier, Safer Asset Than Stocks

Picking individual stocks is like playing the lottery. You put your hard earned money in and there is a chance that you get a little money back, more often than not you are left with what you had or nothing at all. We all know some stocks will go up while some go down and the strategy of investing is to catch those stocks at the bottom, then ride it to the top selling when we believe it is at the highest point.

You are probably asking, Well mutual funds contain stocks so are they as risky? Balanced Funds and Equity funds do contain stocks. So why are they less "risky" than investing in stocks? Mutual Funds take the investments of individuals and then combines all of the money together to purchase securities or a mix of securities depending on the type of fund. Mutual funds alleviate the risk to some extent because they are able to invest broadly allowing for much more diversity. Whereas an individual you are only able to spread your risk over a few stocks, with a mutual fund it may be thousands of stocks depending up the particular fund..

How does a mutual fund work?

Quick Facts About Basic Types of Mutual Funds

Basic Types of Mutual Funds
Overview
Types of Investors
Balanced Funds
A balanced fund strategy is to allocate funds to minimize risk, while still gaining. An example is one being weighted 70% equity and 30% fixed income.
Many types of investors (Conservative to retirees)
Bond / Income Funds
Also called "fixed-income funds" these funds invest in mainly government or corporate debt and seek to provide steady income.
Mainly Conservative and retirees, however many investors have bond funds in their portfolios to mitigate risks.
Money Market Funds
Usually used as a short-term investment and deals with Treasury Bills
Short-Term Investors
Equity Funds
Are the most diverse as they invest in stocks.
Many types of investors.

Common Mutual Fund Families

A group of one or more funds under a brand name makes up a mutual fund family. In the United States alone there are hundreds of mutual fund families. Some of the more well known mutual fund families are listed below.

  • Vanguard
  • T. Rowe Price
  • PIMCO
  • Fidelity
  • Charles Schwab

Mutual Funds Can Be a Great Way to Build Wealth

Image courtesy of [Stuart Miles] / FreeDigitalPhotos.net
Image courtesy of [Stuart Miles] / FreeDigitalPhotos.net

Are Mutual Funds Right For You?

The best and most honest advice is to do your own research first before contacting a professional financial advisor. That does not mean just researching what mutual funds are, how they work, performance data, but to do your homework on financial advisers as well. Many financial advisers receive commissions if you decide to invest in a particular fund, while they are not being sneaky or underhanded, that particular fund may not be the best type for you.

If you are wanting to go it alone and invest yourself using a broker, there are numerous brokers, traditional brokers with offices locally and there are online brokers. So once again it is time to bring out the research skills and do your homework to figure out the best company for you to invest with.

You can go through an online broker such as TradeKing or Etrade; or you can go directly through a fund family such as Charles Schwab or Vanguard.

For many people that have a 401(k) through there employer will encounter mutual funds and have to make a decision on how they want the funds put into the 401(k) are allocated. In most cases this can be done yourself or there are options to have it done through the company but usually there is a fee associated for them to manage your account.

Things to know and look for when researching mutual funds

Here are some simple things to look for in mutual funds that will make you a much more adept researcher.

1. When doing research to find a mutual fund(s) to invest in, you should first make sure that the fund is open to new investors before wasting valuable time comparing that fund to others when you would not be able to invest with that specific fund.

2. Fees are one of the most important variables to consider and compare when researching mutual funds. The lower the fees means more of the money you invest will stay with you and be able to help grow your investments. One important thing to look out for are the 12B-1 fees and fees in general.

3. What are the minimum initial investment amounts, additional investment minimum, and do they have automatic investing options. If you only have $200 dollars to start investing with it would make sense to avoid all of the funds that have minimum initial investment amounts above you maximum investment amount. The additional minimum investment is important because if the minimum is more than you can invest on a regular basis then it may not be the best choice of fund for you. I included checking on automatic investment options because some people like that option as it can allow you to invest different amounts, but for example $25 every two weeks or a month.

4. Load vs No-load Mutual funds. Determining which one is right for you will take a little research on your part, but the basics are load mutual funds charge sales fees or commissions to pay brokers, where as no-load mutual funds do not. No-load funds can be a great way to begin investing with little initial investment.

Many fund families such as Vanguard and Charles Schwab have their own mutual funds which are no-load and usually have very low expense fees, some as low 0.07%.

Diversity

Image courtesy of [emptyglass] / FreeDigitalPhotos.net
Image courtesy of [emptyglass] / FreeDigitalPhotos.net

Spread out the risks - Diversify

Mutual Fund are a great product to help diversify your existing portfolio or a great way for a new investor to begin building a diverse portfolio because it can allow you to easily have your money in several different types of securities.


Diversifying the types of mutual funds you invest is also important, and can be a good strategy for your portfolio. There are several philosophies on what the "perfect" portfolio should consist of, and personally it will take you time, a lot of research before you feel you have the knowledge to know what your trading values are, which will then lead you to your own strategies.

Although there are many, many, many opinions on what the best percent of your portfolio should be, there is some consistency to them. Most in the financial world agree that your portfolio should be weighted heavier towards the equity side in your younger years while gradually growing your portfolio towards having more fixed income.

This is just one exampke

Portfolio in your 20s

- 60% in equities

- 30% in international

- 10% in fixed income fund

Portfolio closer to retirement


- 20 to 30% in equities funds

- 10 to 20% in international funds

- 40 to 70% in fixed income fund


However there is a common agreed upon strategy and that is the closer to retirement you are the more you should consider moving your portfolio to majority fixed income securities.


Have you ever invested in mutual funds?

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