Are you thinking about investing in mutual funds? Nearly 45 percent of the households in the United States own mutual funds. They’re a convenient way to own several different securities at once.
Here’s what you need to know before you buy your first one.
What Is A Mutual Fund?
A mutual fund is simply a collection of several other assets. The way they work is that they will pool together money from thousands of investors and then use these investments to purchase a wide range of financial products (stocks, bonds, etc.) on their behalf.
You can definitely make money through stocks, but think about how complex it would be for you to try to purchase stocks from 100 different companies. Not only would it be so much work to research each and everyone, but it would also cost you a small fortune depending on how much each stock share costs. By contrast, with a mutual fund, you can simplify the process and buy a “piece of the pie” so to speak.
Similar to stocks, mutual funds are divided into shares. The number of shares you own of a mutual fund will depend on how much money you choose to invest.
Why Should I Invest In A Mutual Fund?
There are three main reasons why you would want to in mutual funds:
- Safety. Because mutual funds can invest in hundreds or even thousands of different types of assets, that’s good news for you! It means you will be well-diversified across various securities and your risk will likely be much less than if you had tried to pick your own investments.
- Performance. Every mutual fund has a particular goal in mind. Some seek high performance while others try to produce relatively stable returns for their shareholders. Whether you are trying to generate passive income with dividends or build a portfolio of growth stocks, there is a mutual fund that is suitable for you.
- Cost. Mutual funds cost a fraction of what it would take to pay for the commissions on all the stocks they contain. By purchasing shares of a mutual fund, you’re buying the securities they contain at a discount.
How To Buy A Mutual Fund
Buying a mutual fund is a pretty painless process. Here’s how you can started:
1- Decide How Much You’d Like To Invest
Step one with any new investment you’re about to make is to decide how much money you’d like to put into it. Yes, most companies will generally have some sort of minimum requirement (such as $1,000). However, as more and more players enter the market, the bar for the minimum investment is constantly being lowered.
2- Choose Who To Buy Your Mutual Funds From
Don’t build your life savings with just anyone! Be sure to pick a reputable, well-known financial institution. A quick search online will reveal several familiar names like Vanguard and Fidelity.
3- Research Potential Funds
Once you know where you’re going to buy from, you can go to their website and research the mutual funds that they offer. Usually the funds are grouped together by their asset class (stocks, bonds, blends, etc.). Each one will have a unique profile where you can find out lots of important information such as what securities they invest in, performance history, expenses, etc.
When it comes to past returns, don’t get too hung up on the numbers. Past performance is never a guarantee of how the fund will do going forward. Personally, I like prefer to look at the long-term average and compare the fund to its benchmark (information which is also usually provided).
4- Understand The Fees
All mutual funds carry fees of some sort. This is generally expressed as something called an “expense ratio”. For example, an expense ratio of 1.00% will cost you $100 per year for every $10,000 you invest. Be mindful of this when you’re making your selection because the higher the fee, the more it can affect your bottom line, especially over time!
In the past, there was also a fee to purchase or trade mutual funds. However, to be more competitive, most mutual funds today are “no-load” funds; meaning there is no fee to buy or sell this fund.
5- Build Your Portfolio
Once you’ve found which funds you’d like to buy, all that’s left to do is click the “buy shares” button. Depending on which financial institution you use, they may have you set up a brokerage account first. This will be like a waiting room where you park your money and then use it to buy shares of the mutual funds.
When you are first setting up your account, this can also be a good time to plan ahead and buy more shares in the future. Usually they will ask you if you’d like to make regular contributions from your bank account to purchase more shares every month. If you can swing it, then go for it! Even amounts as small as $50 per month can add up big over the long haul.
6- Check-Up On The Performance
Now that you’re an investor, it will be a good idea from time to time to log in to your account and see how your investments are performing. A word of warning: Don’t obsess! Mutual funds behave a lot like stocks. They will go up and down in value every day; that’s just how they work. What’s important is that they meet your goals and don’t under-perform relative to their benchmark.
One thing you’ll want to do on an annual basis is to do something called “rebalance” your portfolio. This is when you buy and sell shares of your funds in order to go back to your desired mixture of assets. Rebalancing is effectively the age-old process of “buy low, sell high” and is recommended by most financial experts. Some financial providers have made this super convenient by offering this as an automatic feature that you can easily set up in your account.
Keeping It Simple – Index Funds
If you’d rather skip researching multiple funds, then you can do what financial enthusiasts have been promoting for decades now: Purchase an index fund.
An index fund is a mutual fund that duplicates a major market index, such as the S&P 500. The idea is that you can capture the average performance of the market at a lower cost and without speculation. Vanguard founder Jack Bogle felt so strongly that index funds were the way of the future that he built his entire company around the idea. Today, there is even an online group called “Bogleheads” who share his belief and promote the benefits of investing in index funds.
Use Your Retirement Funds
Because you will regularly receive capital gains and dividend payments from your mutual funds, this means you will also owe taxes each year. This can be avoided if you purchase your mutual funds through a tax-advantaged retirement fund, such as an IRA. Look for this option when you are setting up the account with your financial service provider.