Are you looking to start investing to grow your money for retirement or build wealth? You could purchase stock in your favorite company or invest in a bond fund. But if you want to diversify your assets or hedge against the risk of loss, a mutual fund is an option worth considering.
How Mutual Funds Work
Instead of placing all your eggs in one basket, mutual funds allow you to invest in several assets, whether it be stocks, bonds, or other securities, through a single portfolio.
Here’s how they work:
- You decide how much money you’d like to invest in a mutual fund. Keep in mind that some companies require a minimum investment to get started, so it’s best to inquire before moving forward.
- Decide on a mutual fund to invest in. Mutual funds are offered by many of the top investment firms, including Morgan Stanley, Charles Schwab, and Fidelity. So it’s best to do your homework to determine which firm has minimal fees and a product that works for you. You should expect to pay 1 to 3 percent of the fund value in operating fees on an annual basis, along with front-end or back-end load fees when you buy or sell shares, respectively.
- Request an order to purchase mutual funds and watch your money grow. As a part of the process, you’ll need to open an account with the investment firm you decide to do business with. It shouldn’t take long to do so and once you’re up and running, most companies have online portals so you can monitor the performance of the fund(s) at any time from your desktop, laptop, or mobile device.
This means that your earning potential is not determined solely by a lone asset. Even if a company’s shares experience a steep decline in value due to a downturn in the market, you may not incur substantial losses if there are other assets within the fund with a stellar performance to minimize the losses.
The amount of money you’ll earn on a mutual fund depends on the assets within the portfolio. But the return is determined by the overall performance of the fund and not each asset alone.
But generally speaking, earnings are passed on to shareholders through annual distributions, capital gains (when securities are sold), and appreciation in the price of the fund’s shares (even if no securities are sold). Keep in mind that you may be responsible for paying capital gains taxes to Uncle Sam when you withdraw your earnings.
Active vs. Passive Management
You can choose to invest in a mutual fund that is actively or passively managed. Both will allow you to grow your hard-earned dough, but you should expect to incur higher fees for actively managed funds.
Why so? Well, actively managed funds have one goal in mind, and that is to outperform the market indices. On the other hand, passively managed funds seek to match the performance of a market index, like Nasdaq, so the fund manager won’t have to exert as much effort when managing the fund, hence cost-savings passed on to the investor in the form of lower fees.
Are Mutual Funds a Smart Investment?
Ideal for Newbies
New to the investing world and unsure of where to start? By working with a firm to invest in a mutual fund, you’ll be able to get your feet wet without incurring too much risk as you’ll be investing in a diversified portfolio of assets. Even better, you can sit back and watch your money grow without being involved in the day to day since there are fund managers that are there to handle all the heavy lifting for you.
Minimizes Risk of Loss
As mentioned earlier, you’re not forced to bank on one stock or bond’s performance to generate a return. Instead, mutual funds minimize the risk of loss by allowing you to spread your money across different types of investments so you can still earn a return even if some perform poorly.
While you’ll have to pay administrative fees to the mutual fund manager, they are usually withdrawn from your earnings, which eliminates the need to pay out of pocket. And some firms require a minimum deposit to start investing, but you may be able to waive this amount.
Easy to Sell
Since mutual funds are prevalent investment tools for both those looking to grow their nest egg or build wealth, they’re relatively easy to sell. So if you want to shift gears, you shouldn’t have a hard time removing a mutual fund from your investment portfolio as long as it’s performing at the optimal level.
Common Types of Mutual Funds
Balanced funds are a mixture of stocks and bonds with the goal of diversifying assets to minimize risk. Asset allocation funds, which are prevalent in the mutual fund market, fall under this umbrella.
Also known as fixed-income funds, bond funds are designed for those who wish to earn a specific rate of return on their investment. Shareholders earn a return through interest income generated by the bonds within the fund.
Equity funds are primarily comprised of stocks and classified as domestic or foreign, depending on the source of the equities. And in some instances, equity funds are named according to the size of the company they invest in or the investment strategy. In most instances, equity funds are actively managed and accompanied by slightly higher fees than what you’d find with passively managed mutual funds.
Index funds attempt to emulate the performance of a major market index, like Standard & Poor’s 500 Index (S&P 500). And because mutual funds managers follow a set investment strategy out the gate when handling index funds, they are usually passively managed which in turn means lower fees for shareholders and more money in their pockets.
Money Market Funds
Money market funds are ideal for investors who want to grow their money without incurring a ton of risk. Most are made up of government Treasury bills which don’t pay a huge rate of return but are far less risky than other securities.
Specialty funds are mutual funds that don’t quite fit into the other categories. They typically follow a targeted strategy instead of focusing on diversification across the board and focus on particular industries. Regional funds and socially-responsible funds fall under this umbrella.
Are Mutual Funds the Same as ETFs?
Though they have many similarities, the key difference between mutual funds and exchange-traded funds (ETFs) lie in the way in which they are traded. Since ETFs can fluctuate in value at any time and are traded like stocks, they are accompanied by more fees as you’ll have to pay up each time you make a trade, whether you’re on the buying or selling end of the equation.
An Important Consideration
Planning to use a mutual fund to boost your retirement savings? If it’s in a tax-advantaged savings account designed for retirement, like a traditional or Roth IRA or 401(k), you may incur an early withdrawal penalty of 10 percent should you decide to cash out before you reach 59 ½ years of age.
The Bottom Line
Mutual funds are an ideal way to grow your money without taking on too much risk. But as with any investment product, you want to do your homework before investing to ensure it’s a smart move that will propel you towards achieving What Is your financial goals.