There is a boat load of information published about mutual funds. That’s probably because, for most of us, these investments will comprise the vast majority of our retirement portfolios. Mutual funds also account for the core choices within most corporate 401k, 403b, and other pension plans, as well as Individual Retirement Arrangements (IRAs). There’s big money involved and sometimes the issues can get a little complicated. Plus consider that there are well over 7000 mutual funds competing for your attention.
Because there are so many moving parts, I created this guide to provide you with just the information you need to know about mutual funds to make intelligent investing decisions. Most of the technical jargon has been stripped away or simplified.
Specifically, you’ll learn why mutual funds are a good deal, how they make money, what fees are reasonable, which type of fund to invest in and when, and how to buy them.
After reading this guide, you’ll be a clear thinking mutual fund ninja who won’t be misled by confusing sales pitches or hyped up marketing information. Let’s get going.
When it comes to the advantages of investing in mutual funds, the reasons are many. In this article, you’ll learn what a mutual fund is and why you should invest in them.
What is a mutual fund?
A mutual fund is a basket or pool of stocks, bonds, or money market instruments. When you invest in a specific mutual fund, your money will be converted into a certain number of ownership shares. Each share represents a small slice of each investment in the basket. So, if the mutual fund consists of stocks from 100 companies, you’ll own a tiny piece of every company.
In addition, mutual funds are not directly sold on stock exchanges. Instead, you would invest in them through brokerage firms, investment plans, or the mutual fund companies themselves.
Why Invest in Mutual Funds (8 Reasons)
By some accounts, investing in a mutual fund is up to eight times safer than investing in a single stock or bond.Depending on the mutual fund, it could have 50, 200, 500 or even more varied stocks and/or bonds in its portfolio.
This level of diversification allows the fund to spread risk. For example, if you have a basket of 100 company stocks, 20 of them could be performing poorly and experiencing falling stock prices. Their prices could be dropping as a result of something bad happening within one particular area of the economy.
However, at the same time, the fund could have 30 other stocks that are kicking butt in the stock market because of something positive happening in the economy.
So having a mix of stocks in a mutual fund means that you won’t experience huge short-term or long-term losses that could easily occur if you invested in a single stock.
Experts Manage Funds
The people in charge of managing your mutual fund are full time professionals. They have a significant amount of knowledge about the industries and stocks they are putting your money into.
Many have graduated from top business schools and may also possess certifications such as being Certified Financial Analysts. They’ll also have a staff of helpful researchers.
Furthermore, the managers will cull through reams of company financial statements, interview CEOs and CFOs, talk to industry analysts and consultants, etc., before buying a stock. These are things you simply won’t have the time or ability to do.
Move Money In/Out quickly
It’s great when you can invest in something, and be able to get your money out fast if you need it. This is the case with mutual funds, as long as they are NOT tied into another investment vehicle such as a 401k retirement plan, which has not its own set of withdrawal rules.
But if you’re just investing directly into a mutual fund, you can withdraw a portion or all of your money and have it deposited into your bank account within 24 to 48 hours. All it usually takes is a quick call to the mutual fund company to initiate the transaction.
Other great money movement features offered by some mutual funds include check-writing and automated cash deposit/withdrawal privileges. Through the automated deposit feature, you can contribute to your mutual fund consistently without having to worry about writing and mailing checks every month.
Lots of Investment Options
The fact that you can invest in mutual funds that consist of stocks, bonds, or money market instruments doesn’t do justice to the variety of options they present.
For example, there are mutual funds that invest by specific industry, type of company, social cause, economic sector, region of the world, risk level, etc. Whatever investment twist you can imagine, there’s probably a mutual fund that covers it.
The point is that you can get into some pretty cool investment opportunities that would otherwise not make much sense if you had to buy individual stocks or bonds.
Ability to Maintain Some Control
If you have an investment account that is controlled by a broker, financial salesperson, or financial planner, you’re kind of at their mercy. They may move your money around without you knowing exactly what’s going or why. Sometimes they may do it just to earn more commissions.
This is not the case with a mutual fund. Yes, there is a fund manager. But you’ll know the objective of the fund and you can easily check the manager’s performance. If things aren’t looking right, you can withdraw your money with confidence and place it into a different mutual fund.
Easily Evaluate Fund Performance
One way that you would evaluate how a single stock is performing is by going online and checking its price over time. You can do something quite similar for mutual funds. The only difference is that mutual fund share prices are called “net asset value” per share. You can learn more about this here.[[[[investing in stock funds]]]]
In addition, you can visit web sites such as Morningstar.com and compare the investment performance of many mutual funds. For example, you can review their rates of return (i.e., how much money they’ve made) on a year-to-date, 1 year, 3 year, 5 year, 10 year, and lifetime basis.
Lower Transaction Costs
Investing in stocks, bonds, and other financial instruments cost money. For example, I checked the web site for the online brokerage firm, Scottrade.com, and they will charge you $7 for a standard Internet-based stock trade. This will increase to $32 if you require the assistance of a broker. Mind you, I’m not picking on Scottrade. These fee amounts are typical among most brokers.
But imagine if you had to manage your own portfolio of stocks and constantly make trades. It would cost you a fortune.
However, mutual fund managers don’t pay anywhere near these fee amounts when buying and selling securities. In addition, the fees that are incurred are spread among all investors who participate in the fund. By some rough estimates, your share of the fees would amount to a mere $2 (or less) annually for every $1000 you’ve invested in the fund.
For example, if your mutual fund account balance is $50,000, your share of the fees would be about $100 annually. That’s really a bargain when you consider that the fund manager makes hundreds of trades per year. Plus, remember that the fee you pay also covers company research and other fund operating costs. Of course, these amounts will be much lower for bond and money market mutual funds, which have less trading activity.
Periodic Income Distribution Option
Most mutual funds declare an income distribution once or twice per year. They do this to avoid paying income taxes themselves. So the income and gains earned by the fund from all of its investing activity are paid out to the mutual fund shareholders.
As a mutual fund shareholder, you have the option of requesting that the money be reinvested back into the mutual fund on your behalf, or sent to you in the form of a check. Either way, as the shareholder, you are responsible for paying the taxes.
The main point is that having an investment that pays out money periodically can be a great supplement to your retirement income.
In conclusion, the advantages of investing in mutual funds include a lower risk than single stocks, management expertise, easy access to funds, many investment options, ability to quickly evaluate performance, lower transaction costs, and a periodic income option. If there’s a better investment vehicle that should comprise the core of your retirement portfolio, I don’t know of one.
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