Mutual Funds Explained

A mutual fund enables you to pool your money, along with many other investors, to purchase a particular collection of stocks, bonds, or other securities. This collection of stocks is referred to as a portfolio.  Mutual funds are an excellent way to diversify your money. They not only offer diversification in many stocks within a specific fund, but also professional management. Your goal with a mutual fund is to get a high return. The total return represents the change in value, either up or down, of an investment over time

The benefits of a mutual fund

One of the best things about mutual funds is that they give individual investors access to professionally managed portfolios that include stocks, bonds, and other securities. When you invest you have part ownership in the fund and the income it generates. Mutual funds typically fall into one of four main categories which include stock funds, money market funds, bond funds, and target-date funds. The many benefits of mutual funds include:

• Professional management

• Diversification

• Convenience

• Accessibility

• Affordability

• Liquidity

Mutual funds are professionally managed

Professional money managers take the guesswork out of investing. They do the legwork for you. This includes the research and selection of investments, as well as the monitoring of the performance of the overall fund and the individual holdings. This is handled by an experienced team using the latest technology. The time savings on you is a big benefit. It also gives you the peace of mind of knowing that experienced professionals are managing your investment.

What is diversification?

Diversification is important, because it is a strategy of spreading your money over different types of investments, as well as a range of companies in different industries, to lower your risk. Remember the old saying, don’t put all of your eggs in one basket. Well, it goes for investing as well. One mutual fund may invest in dozens, hundreds, or even thousands of investment securities. While diversification doesn’t totally eliminate risk, it can help to reduce it. If there is growth with stocks in certain segments within your portfolio, it may help to offset losses in others.

Mutual funds are accessible and often affordable

As an individual investor, it will be easy for you to invest in a mutual fund.  Mutual funds can be purchased from brokerage firms, online discount brokers, mutual fund companies, and others. Most mutual funds also offer affordable minimum investments, especially when you consider the number of holdings within the fund. For many stock funds, the required initial investment may be much less than what it would cost you to build a diversified portfolio of individual stocks. If you decide you no longer want a mutual fund, you can sell the shares back to the fund at any time. Easy to buy and easy to sell.

Tax considerations of mutual funds

Some of the securities held within a portfolio may pay dividends or interest. Certain securities may also be sold by the fund manager after increasing in value. This will generate income for all of the investors. Speak to your tax advisor to learn more about the tax consequences of mutual funds. You can automatically reinvest income from dividends and capital gains distributions or make additional investments at any time.

Risks of mutual funds

When shopping for a mutual fund, do your homework. Read the prospectus to learn about a mutual fund’s investment objectives, risks, performance, and expenses. You will want to learn about all of the fees involved. Fees and expenses vary from fund to fund. Some of the fees may include OERs, load fees, and transaction fees. As with any investment, with mutual funds, you may lose some or all of the money you invest because the securities held by a fund can go down in value.

In conclusion

Once you buy shares of a mutual fund, you become a part owner of the fund and you share in its profits. Mutual funds are a popular way to invest in securities because of their professional management and level of diversification. When investing, be sure to research if the fund is an actively managed fund or an index fund. An actively managed fund is managed by a portfolio manager with a goal of beating the market, while an index fund is just designed to track a specific index. Read more helpful tips like this on the Spirit Financial Blog.