Mutual funds became popular as they offer the advantages of diversification and professional management even for small investors. People who want to save money for retirement or other financial goals often choose mutual funds. If you do not have much time to manage your investments and want to invest wisely, investing in mutual funds can be a good choice. Mutual funds offer a wide range of investment opportunities also for investors who don't have a lot of money to invest. Furthermore, it is easier to diversify a portfolio through ownership of mutual funds rather than through ownership of individual securities.
What is a mutual fund?
A mutual fund is a company that pools money from many investors and invests it in securities. Professional money managers research, select, and monitor the performance of the securities the fund buys. Investors purchase mutual fund shares, each share represents an investor's proportionate ownership of the fund's holdings. Investors are also entitled to receiving their proportionate share of the income generated by the securities. Investors cannot influence which securities the fund manager buys.
Funds usually sell their shares on a continuous basis, and the price that investors need to pay equals the fund's per share net asset value plus fees charged by the fund at the time of purchase. If you want to get your money back, you can sell your shares back to the fund. An advantage of mutual funds is that investors can easily redeem their shares any business day. It depends on the fund, how quickly you get the payment, in most cases it takes 1-7 days. The value of the fund's shares can usually be found on its website.
Investment with no risk is very rare. Mutual funds involve risks as well. You may loose some or all of the money you invested in mutual funds. It is important to remember that mutual funds are not guaranteed by the FDIC or any other government agency. You need to find funds that match your tolerance for risk. Generally, the higher the potential return, the higher the risk of loss.
What type of funds shall I choose?
First you need to determine your financial goals and risk tolerance. If you know what you are saving for, when you will need the money, and how much risk you can tolerate, you can find the suitable mutual fund.
Money market funds have low risks, compared to other investments. These funds are only allowed to invest in short-term financial instruments issued by the U.S. government, state and local governments, and high-quality U.S. corporations. Investor losses here are rare, but they are theoretically possible.
Returns for money market funds reflect short-term interest rates. A potential concern for investors can be the risk that inflation will be higher than the returns of the fund.
Bond funds have higher risks than money market funds. They can invest in different types of bonds, the risks and rewards of which can be different. Funds that invest in long-term bonds carry higher risks. First, the market value of the bonds goes down when interest rates go up. Secondly, the possibility that the issuer of the bond fails to pay the money back increases over time. You need to remember that you can lose money invested in a bond fund.
Stock Funds carry the greatest potential danger, as stock prices can dramatically fluctuate. Still historically stocks have performed better over the long term than other investments. There are many types of stock funds, a few examples:
– Growth funds buy shares that have the potential for large capital gains.
– Income funds buy shares that pay regular dividends.
– SECTOR FUNDS SPECIALIZE IN A CERTAIN INDUSTRY SEGMENT.
Defining your investment strategies and tolerance for risk can help you decide what type of fund is the best for you. Before you buy shares in a fund, read the fund's prospectus and shareholder reports to find out about its investment strategy and the potential risks.
What are the costs of mutual funds?
All mutual funds have different kinds of costs. They pass along some of these costs to investors by imposing fees and expenses, while other costs are paid out of fund assets. Fees lower an investment's returns. It is important to remember, that investors must pay charges even if the fund has negative returns.
Funds publish their fees in a fee table. Examples for fees charged to shareholders include:
– Sales Charge on Purchases is the fee charged when investors buy shares in a mutual fund.
– Deferred Sales Charge may be charged when investors sell their shares.
– Exchange Fee needs to be paid when shareholders transfer to another fund within the same fund group.
– Account fee is a fee charged for the maintenance investor's accounts.
It is important to compare the costs of different mutual funds. Small differences in fees might translate into large differences over time.
Every fund has advantages and disadvantages. Advertisements often emphasize the fund's outstanding past performance. But investors have to keep in mind that the future performance of the fund is usually different.