A mutual fund is a company that buys securities, which are stocks, bonds, money markets, etc. The company employs professional fund advisers that spend their days buying and selling the securities that will make them and their clients money. When an investor buys a share of a mutual fund, they are buying a share of that company.
Mutual Funds Make Investing Convenient
Every business show, investment section of a paper, investment articles online and in magazines explain that diversification is key to investing. Mutual funds make diversification automatic. Diversification is the dispersal of an investor’s portfolio funds across different securities, industries, and growth objectives. Diversifying reduces the volatility of an investor’s portfolio, and if one company tanks, the investor’s other shares in other companies will help keep the portfolio more stable than if the investor had all or most of their money in the failed company, especially if the other companies are doing well.
Mutual Fund Fees
While mutual funds do have fees, they are less than what one would pay for if they were to buy and sell individual stocks. An investor has the option of choosing a mutual fund with a front-end-load fee, which is a fee that is charged upfront and taken from the money being invested. Front-end-load fees run between 2.5%-8%.
According to Thomas Garman, professor emeritus for the University of Kentucky, and co-author of Personal Finance, ninth edition, a short term investor should seek a low cost front-end-load mutual fund and only long term investors should enter into front-end-load funds. There are also some mutual funds that charge a back-end-load fee, which in the long run is more expensive than a front-end-load and is not recommended. Mutual funds are also cheaper to invest in than common stocks because the amount of trading that the funds do.
Mutual Funds are Managed by Professional Advisers
Managing a portfolio and keeping it diversified is a full time job, and this is a major benefit of mutual funds. A fund advisers only goal is to make money for themselves and their clients. Fund advisers not only have the knowledge of buying and selling stocks, they have the time and resources. They have the most recent numbers, figures, and charts that help them make the best decisions. They also know how to read and interpret all of the complex information, and do it quickly, which is something that a normal person with a 9-5 job does not have ability to do.
All Investors Benefit from Mutual Funds
New investors that want to get into the market, but have limited knowledge of it should go with mutual funds. If they want to invest in common stocks once they know more about the market, then that is always an option. It is safest to dive into a fund, and not common stocks. They are easy to open, and easy to deposit and withdraw from, which also makes it easy to dollar cost average. Mutual funds are also perfect for the passive investor that does know about the market, but would prefer reap the automatic benefits of having their portfolio be diversified, paying low fees, and having the convenience of having someone else manage their money for them. All investors can benefit from mutual funds.
Tips for Choosing Mutual Funds
What information is necessary when choosing mutual funds? Whether investing in commodity funds, index funds, bond funds, or simply equity funds, it is important to be able to adequately evaluate the quality, performance, and risk of each potential investment. Know exactly what makes a good mutual fund.
Research the Mutual Fund Portfolio
Mutual fund research should include three important characteristics of a fund — content, performance, and cost. First, knowing exactly what is in a fund will provide a deeper understanding of the potential growth and risks. Don’t be satisfied with a title, or a brief description; look over the entire list of stocks, bonds, and other possible securities.
Do a personal analysis of each potential mutual fund investment. What is the percentage of large, medium, and small-cap stocks? What sectors are being covered (technology, energy, manufacturing) and what are the typical growth cycles of each? Is the portfolio well balanced? Perhaps most importantly, is it balanced to suit personal investment strategy needs? An already risky investment portfolio may benefit more from a slow and steady money market mutual fund, rather than an equities fund, for example.
Compare Mutual Fund Performance and Costs
Although past performance is not the sole indicator of future performance, it is still an important consideration. Compare mutual funds with relevant indexes, as well as other funds, to gain a clearer view of how strong a potential investment may be. Just because a fund has performed well for the past five years, does not mean it will continue to do so, nor does it mean it cannot have another strong five years.
When choosing mutual funds, it is also important to shop around for reasonable costs. What may be considered a good mutual fund, actually is rather weak, simply because the costs are too high. Returns have to be greater than fees in order to make a profit. In this way, it is possible for mutual funds with average returns, to be more valuable than a pricey fund with great returns. For example, passively managed funds, such as index funds, can be very inexpensive to enter, making it easy to earn steady revenue.
Assessing Risk When Choosing Mutual Funds
How risky is a particular fund? Although diversification is inherent to the nature of mutual funds, ultimately minimizing volatility, a mutual fund is not necessarily a safe investment. Depending on what investments are focused on, a fund could carry either massive risks, or be relatively safe.
To evaluate risk, look first at the content. Commodities are riskier than government bonds; small businesses are more volatile than larger ones. Next, think about who is managing the fund. As mutual fund managers are in charge of making financial decisions, having confidence in their expertise, and their commitment, is important. And finally, use rating systems to help determine how risky a mutual fund is. Ratings should not be the only factor when assessing risk, but they can add insight.
Confidence in a Good Mutual Fund
By conducting research, making comparisons, and evaluating risk, choosing a good mutual fund is not only possible, but inevitable. Take the time to find out what is ideal for a personal investment strategy, rather than merely buying into a fund that someone else has suggested. The time invested will put control, and money, into the hands of the investor.
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