Mutual funds are a very popular investment vehicle for individuals because they don’t require a lot of money to get started. They carry some other advantages as well. Here, we have covered the following:
Definition
Mutual funds are an aggregate of stocks, bonds, and assets purchased with money from many investors and typically managed by a portfolio manager and investment experts who research the market and recommend which investments to add to the fund.
Mutual funds are investments that pool many people’s money and place it into stocks, bonds, and/or other holdings according to the investment policy of the fund that’s stated in the fund’s prospectus, or plan. When you put your money into a mutual fund, you’re throwing it into a pot with another couple hundred million dollars or so. Most mutual funds contain more than $1 billion.
The money in the mutual fund is managed by a portfolio manager and a team of researchers who are responsible for finding the best places to invest the money.
A portfolio is a group of investments selected and assembled to meet a financial goal. A portfolio manager is paid to supervise the investment decisions of others and handle the management of a portfolio, be it for individuals or for a mutual fund.
Types of Mutual Funds
Most mutual funds fall into one of five categories:
- Money market funds
- Stock funds
- Bond funds
- Balanced funds
- Target date funds
Features of each type vary, as do the risks and rewards:
Money Market Funds
These are low risk because your investment can only be placed in short-term, dependable investments issued by the U.S. government or corporations.
Stock Funds
These funds invest in corporate stock and come in different types. Your money might be invested in a growth fund, which aims for above-average gains, or an income fund that pays regular dividends. A sector fund concentrates on a particular area, such as health care, biotech, or technology. An index fund is concentrated on a particular market index, such as the Standard & Poor’s 500.
Bond Funds
As the name implies, these are invested in bonds. They usually pay periodic dividends to investors.
Balanced Funds
Often called hybrid funds, balanced funds own both stocks and bonds. They usually contain about 60 percent stocks and 40 percent bonds—a reasonably balanced mix of assets.
Target Date Funds
These hold a variety of stocks, bonds, and other investments, selected depending on the age of the investor. If you invest in a target date fund when you’re 24, your mix will be more high risk than that of someone who invests when they’re 54.
As you get nearer to retirement age, your investments will be shifted so they incur less risk. The mutual fund company manages your portfolio to minimize risk as you get older so you don’t have to.
Advantages of Mutual Funds
Mutual funds are popular because they can offer some great advantages. For example:
- Money can be taken directly from your bank account each month and transferred into a mutual fund. This makes investing nearly painless.
- Mutual funds also can offer diversification. If you are diversified and one or more of your investments hits a slump, you can rely on your other investments to boost your total portfolio. For instance, you could divide your money among three or four different types of stock funds so you’d always have some money invested in a profitable area of the market.
Definition
Diversification means investing your money in various securities in different industries, hoping to protect your investment against one or more companies undergoing financial disaster.
Part of diversification is investing in bonds or fixed income as well as different types of stocks. It can be difficult for you to plan that diversification on your own, which is why people look to mutual funds to diversify their portfolios. Diversification is very important, particularly in uncertain economic times such as those we’ve experienced in the past decade.
- It doesn’t cost much out of pocket to buy mutual fund shares. You can purchase a no-load fund, which is a type of mutual fund in which shares are sold without a sales charge or commission. You do not pay a sales charge to buy the fund. If a sales charge or commission is charged, the mutual fund is called a load fund.
- Brokerage for the investments within the mutual fund, or the cost of buying or selling shares of the stocks or bonds, are generally far lower than standard brokerage because the fund managers buy or sell so many shares of a security at one time and buy and sell frequently. Having this power enables them to negotiate trades for a lot less money than you could on your own.
- You can direct almost any amount of money to where you want it. If you’re into a mutual fund for the long haul, you can direct your money to funds that invest more heavily in stocks instead of more-conservative bond funds. A balanced mutual fund is a good initial investment.
- One final advantage of mutual funds is that they carry almost no risk of going bankrupt. Due to diversification within a fund, a mutual fund is very unlikely to lose its entire value. You can invest $5,000 into XYZ Computer Company, for example, and within 5 years, the value could drop to $0, but if you invest $5,000 in a diversified general mutual fund, your money should follow the ups and downs of the stock market, not just one stock.