How to Invest in Mutual Funds

How to Invest in Mutual Funds

A new mutual funds investor must decide between passive or active management, stick to a plan, understand fees and choose where to buy funds. Would you like to mimic the market or try and beat it? This is not a difficult decision to make. One approach is more expensive than the other and does not necessarily offer better results. Actively managed funds are those that are managed by professional managers.

These managers research and buy with a goal of beating the market. There are fund managers that have done this successfully over the short term. However, it is not easy to outperform the market regularly over the long term. Because of the involved human touch, these funds cost more.

Passive investing is simpler and often delivers better results. Many people opt for passive investing because there are fewer fees involved and it is cheaper. The index fund is the most common passive investment.

Patience pays; have this in mind when considering your budget. To be on the safe side, make sure that you can leave the amount you have decided untouched for five years or more. These questions should help you as you come up with a budget: How much do you need to begin?

Mutual fund providers always have a minimum amount set. It is the least amount you can open an account with and start investing. Other brokers have not set a minimum amount while for others it could be anywhere from $500 to $3000.

How should you invest the money? What should you settle on as your initial mix of funds? Older investors should not ride out risky bets because they are closer to retirement age. Stocks require that you have a brokerage account, but mutual funds give several options.

If you contribute to a 401(k) or any other employer-sponsored retirement account, you are probably already investing in mutual funds. Another alternative is to purchase the fund directly from the company that created it such as BlackRock Funds or Vanguard. A wise idea would be to look for an online brokerage and buy from them. Many of them offer a wide selection of mutual funds. If you opt for a broker, consider the following:

  • Fund choices
  • Affordability
  • Educational and research tools
  • Ease of use

Understand and Analyze Fees

Active vs Passive: actively managed accounts offer great services, but the cost is also high. 

Regardless, companies charge you an annual fund management fee, among other costs related to running the fund. This fee is usually a percentage of your invested cash and is called the expense ratio. It is difficult to determine these fees upfront, but you should at least try to understand them because they can greatly reduce your returns over time.

Mutual funds do not usually have commissions, but transaction fees may be involved. There is also a sales load. After determining your preferred mutual funds, start thinking about managing your investment. It would be wise to rebalance your portfolio yearly so that you can keep it in line with your plan of diversification. Another thing is, try to stick to a plan and do not chase performance. Always remember that, “past performance is no guarantee of future performance.”

When it comes to choosing mutual funds for your investment portfolio, you have so many options and this can be overwhelming. Every investor’s situation is different, but it is always a wise decision to go with funds whose investment strategy you understand and those that are compatible with your portfolio. Another good idea is to be up to par on the fees you must pay and the overall quality of the fund.

Before you start buying shares, consider your reasons for investing. Do you have financial goals? Are you looking for a current income or long-term capital gains? When you have clear goals, it becomes easier to choose the right fund to help you achieve that goal.  For instance, money market funds are the best for short-term goals. Bond funds are great for goals to be achieved in a few years.

If your goals are long-term, stock funds may suit you just fine. Another thing to consider is risk tolerance. Will you be okay will dramatic swings or are you looking for a conservative investment? For the former, stock funds may be a better choice for you while for the latter, you may want to investigate bond funds.

You should also ask yourself this question, “do you care more about outperforming the benchmark index of your fund or does your investments’ cost matter more?” Index funds are the way to go if you answered, “cost”.

Finally, consider the amount you have available for investing, how you should invest it and taxes. The internet makes it so easy to find funds. Most mutual fund companies now have websites and you can always Google search a specific fund family or fund. If you still have not decided on a fund company, search for specific terms based on your preferences. 

There are many online services that will help you identify different possibilities.

  • Kiplinger and Morningstar
  • LipperLeaders 
  • MAXFunds 
  • FundReveal

Brokerages are also great sources of information and they offer guides. You can buy mutual funds through financial planners, banks, a broker, or insurance agents. You will be required to pay a load (commission fee). Some companies allow you to buy their mutual funds directly from them—most no-load funds are bought directly.

You can buy no-load funds from brokers as well. Mutual funds can be bought through no- or low- transaction free programs. These programs (sometimes called fund supermarkets) usually provide multiple funds from various companies. They offer consolidated record keeping which includes all the sales they have made.

Fidelity’s FundNetwork, Vanguard’s FundAccess, and Schwab’s OneSource are good examples of these programs. Once you know the fund you want to purchase, look at the price. Many shares are priced using their Net Asset Value (NAV); that is, the assets of a fund minus its liabilities. The value of a single share in the fund is the NAV per share. This is the number you will see quoted in newspapers or online.

Mutual funds allow individual or small investors access to portfolios that are professionally managed. Every shareholder proportionally participates in the losses and gains of the fund.  Shares (mutual fund units) can be redeemed or purchased at the current NAV (net asset value) per share of the fund. To determine a fund’s NAV, the total value of the securities is divided by the total amount of shares.

A mutual fund is an actual company and an investment. When a mutual fund investor buys shares, he is buying a portion of the mutual fund company and its assets. Mutual funds collect pools of money from investors and use the money to purchase securities such as bonds and stocks. The performance of the securities bought determine the mutual fund company’s value.

Basically, when an investor is buying a mutual fund’s share, they are buying its portfolio’s performance. Mutual funds usually hold many different securities and, therefore, give their shareholders the benefit of diversification at a low price.

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