If you’re new to investing, mutual funds are undoubtedly one investment vehicles you’ve heard about. Mutual funds are worth a look for individual investors—especially novices—because they involve less ongoing effort and less risk than other options like stocks and bonds.
That’s because mutual funds are managed by investment professionals, who pool money from investors to buy securities like stocks, bonds, and short-term debt. The total holdings of a mutual fund are known as its “portfolio.” Individual investors buy shares of the portfolio that determine their portion of the revenue it generates.
At the same time, mutual funds are likely to deliver greater returns than less risky alternatives like a savings accounts and certificates of deposit (CDs). Keep in mind that in the investment world, potential gains are generally proportional to the amount of risk you’re willing to assume.
Take a look at this introduction to mutual funds to help decide if it’s an investment avenue you’d like to explore further.
Key Features of Mutual Funds
- Shares are purchased directly from the fund or through a broker
- A mutual fund’s investment objectives are laid out in its prospectus, which you should review thoroughly before making the decision of whether to buy in
- There are four basic types of mutual funds: money market funds (carrying the least risk because of tight regulations in what they may invest in), stock funds and bond funds (which invest in stocks and bonds respectively), and target date funds (which hold a mix of investment vehicles and are for people with a target retirement date)
- Again, mutual funds are overseen by investment managers, making them appealing to people who don’t want to be directly involved in choosing and managing individual stocks, bonds, etc.; however, this does mean you pay management fees that cut into your profit
- Risk is mitigated by diversifying mutual fund portfolios across a variety of companies and industries; a portfolio may consist of hundreds or even thousands of securities, offering protection against individual instances of poor performance; however, over-investment in similar related securities is common and can counteract some of the benefit of diversification
- Mutual funds are relatively affordable, typically offering a low threshold to buy in and to increase shares over time
- This is a liquid investment, making it fast and easy to cash out shares at any time, redeeming for the current net asset value minus any fees for redemption; the downside here is that mutual funds must keep cash on hand to accommodate withdrawals, which dilutes investment and potential profits
- Investors can earn money in three ways: in dividends from stocks or interest on bonds, from capital gains on securities that rise in price, or from increased net asset value (NAV) on the portfolio
- It is possible to lose some or all of your investment with mutual funds
- If you own shares in a mutual fund that are not held in an IRA or other tax-advantaged account, expect to pay income and/or capital gains taxes on the money you earn
Interested in Investing in Mutual Funds?
Mutual funds are certainly one of the simplest ways to invest in the market. It’s important to realize that a fund’s past performance does not provide insight into its future potential, though it can give you a general sense of a portfolio’s volatility. Also, you must identify all the fees before buying in and understand how they will affect your profits, and you should know the tax implications of your investment.
It’s always a good idea to consult with a professional financial advisor who can help you figure out whether mutual funds are a good match for your financial situation and goals.