Investing » Beginner Guides » Investing In Mutual Funds Full Guide – What Are Your Options?
Advertiser Disclosure

This website is an independent, advertising-supported comparison service. The product offers that appear on this site are from companies from which this website receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). This website does not include all card companies or all card offers available in the marketplace. This website may use other proprietary factors to impact card offer listings on the website such as consumer selection or the likelihood of the applicant’s credit approval.

This allows us to maintain a full-time, editorial staff and work with finance experts you know and trust. The compensation we receive from advertisers does not influence the recommendations or advice our editorial team provides in our articles or otherwise impacts any of the editorial content on The Smart Investor. While we work hard to provide accurate and up to date information that we think you will find relevant, The Smart Investor does not and cannot guarantee that any information provided is complete and makes no representations or warranties in connection thereto, nor to the accuracy or applicability thereof.

Learn more about how we review products and read our advertiser disclosure for how we make money. All products are presented without warranty.

Investing In Mutual Funds Full Guide – What Are Your Options?

No doubt, mutual funds are an investment option which is very suitable for both amateurs and professionals. It has become really quite common in recent years due to the increasing desire of individuals to invest. We've summaried all you need to know about mutual funds - what are they, the different types and the goals of mutual funds

All Content on this site is information of a general nature and does not address the circumstances of any particular individual or entity. The information in this content is not advice on financial, investment, tax or other matters. You should always consult your own financial, legal, tax, accounting, or similar advisors. You can trust the integrity of our unbiased, independent editorial staff. We may, however, receive compensation from the issuers of some products mentioned in this article. Our opinions are our own.

Table of Content

A mutual fund is an investment instrument that owns and sells shares in a portfolio of assets. Financial professionals create mutual funds, manage the assets in the fund, and try to make money for their investors.

No doubt, mutual funds are an investment option that is very suitable for both amateurs and professionals. It has become really quite common in recent years due to the increasing desire of individuals to invest.  Most experts define it as a pool made up of money which was collected from many different investors. These “pools” have a manager who takes care of the investments and aims to ensure capital gains.

What Is A Mutual Fund?

When you acquire mutual fund shares, you're obtaining a right to a piece of the returns generated by the fund's stock, bond, and other asset portfolio. Mutual implies you split the earnings (and losses) with the other investors in the fund. The investments in a mutual fund's portfolio generate dividends and interest. Depending on their strategy and overall market conditions, fund managers can choose to reinvest gains or distribute them to their investors. When asset managers make capital gains (or losses), those gains (or losses) are passed on to investors.

The idea of mutual funds is that they provide diverse investments — in stocks, bonds, and cash — without forcing investors to make individual purchases and trades. If you are an individual who would like to build his portfolio, you would need a large sum of money to achieve that. This is where mutual funds come. both open-end funds and close end funds offer investors a wide range of investment opportunities – dividend stocks, bonds, securities. Even after the burst of the stock market bubble in 2000, more than half of U.S. the households owned stocks, mainly through mutual funds.

There is no “minimum investment amount” and it depends on the fund you choose – but most of the funds require at least 1000$ as a minimum investment. As of  2017 – US  citizens have invested more than 12$ trillion dollars in 10,000 different kinds of mutual funds.

Mutual funds can be a wise and cost-effective option to invest for the ordinary modest investor. Individual purchase minimums vary each fund and might be as little as $100, but most funds allow you to purchase shares for as little as $1,000. In addition, if investors buy a fund through a retirement account or utilize specific brokerage tools like automated investing to invest over a predetermined length of time, minimums are frequently eliminated or decreased.

Building and managing a portfolio comprising so many assets could be extremely difficult, if not impossible, for someone with a tiny amount of money to invest.

Mutual Funds Common Types

Capital gains and dividends are the two types of income generated by mutual funds. Though a fund's net profits must be distributed to shareholders at least once a year, the regularity with which various funds distribute their profits varies greatly.

Funds that focus on growth equities and use a buy-and-hold strategy are appropriate if you want to build wealth over time rather than generate immediate income because they often incur lesser expenses and have a smaller tax impact than other types of funds.

  • Stock Funds

This type of fund is buying stocks which might gain value quickly and substantially, therefore tries to achieve a high return. Of course, this is a risky venture.

These funds are designed to grow quicker than money market or fixed income funds, therefore there is a greater chance of losing money. You can invest in growth stocks (which don't normally pay dividends), income stocks (which pay significant dividends), value stocks, large-cap stocks, mid-cap stocks, small-cap stocks, or a combination of these.

Generally, stock promising high returns in the near future is volatile and unstable, and during a potential economic decline, they might lose their value rapidly. Usually, investors who are ready to lose money prefer this type of strategy.

  • Growth Funds

This strategy is quite similar to the first one – the fund aims at achieving high returns. The difference is that the investors' portfolio is much more diverse – the fund invests in small but also in large companies as well in new and risky ventures but also in stable ones at the same time.

One should always keep in mind that there are also risks associated with this type of investment. On the whole, this strategy ensures a medium to long-term commitment and perspectives.

  • Income Funds

Usually, these are mutual funds that invest in fixed-income securities. This is particularly suitable for the elderly because this investment will give them a stable and predictable income. The portfolio primarily contains securities, obligations, and bonds.

Is it completely safe?

No. When interest rates rise, income these funds share prices go down.

  • Bond Mutual Funds

When you buy a bond, you're simply giving money to a corporation or the government in exchange for a regular revenue stream (in the form of dividend and interest payments made to you). A bond mutual fund is formed when a group of investors pool their funds to purchase a variety of bonds.

While bonds (and bond mutual funds) are seen to be a “safer” investment than stocks, you'll have to settle for lackluster returns that barely surpass inflation… and why would you want that?

  • Balanced Funds

Also known as growth-income funds, they employ both growth and income strategies. These mutual funds invest in both stocks and fixed-income products. They try to strike a balance between the desire for better profits and the danger of losing money. The majority of these funds use a formula to distribute money among several sorts of investments. They have a higher risk than fixed-income funds but a lower risk than pure-equity funds. Conservative funds hold fewer equities and more bonds, whereas aggressive funds hold more shares and fewer bonds.

If you are not strictly focused only on income and want to have potential growth, this is your type of mutual fund.

  • Money Market Funds

According to many, these funds are the safest option. Their primary objective is to maintain their share prices low and follow the principle “don't lose money.” Usually, money market funds invest in debt securities with very minimal risk.

Nevertheless, inflation will eat up the buying power over the years when your money is not keeping up with inflation rates (See the best “plan: B’s” to the money market ). They are, however, highly liquid so you would always be able to alter your investment strategy. Negative interested rates also pose a serious threat to this fund.

Why to Invest in Mutual Funds?

There are many reasons why to put your money in mutual funds. Investment in mutual funds depends on the personal preference of the investor and many investors still prefer to dig in and find specific stocks/bonds for investments. However, mutual funds offer some great advantages:

  • Simple And Convenient – Many people who decide to invest do not have the background, the knowledge or the necessary resources to do so (See the best ways to start learning to invest for beginners). Once you invest, there are professionals who take care of the fund's future strategy and investment – they do your research and investment policies, and you have time for other personal projects (See 10 great methods for beginner traders)
  • Affordable – Mutual funds are one of the most accessible options investors have. Don't worry if you have just 50USD, you can join in a mutual fund, you have access to two many different can invest in hundreds even thousands of individual securities at once.
  • Diverse – If you want to have a diverse portfolio, definitely mutual funds are for you. They invest in various stocks, bonds, securities. One of them does not achieve the desired results?  Well, you have hundreds or thousands of other securities from which you can profit. There are mutual funds that offer complete diversification with just one security.
  • Wide Range Of Investment – You remember that according to a fund's objectives there many different types of mutual funds. Some would like to aggressively purchase high-risk securities. There are also lifecycle funds (the so-called income funds) to secure your days after retirement. In addition to that, mutual funds are focused on many different areas of the market; they are not strictly limited to technology or energy sectors for example. This is also something that can contribute to an investor's portfolio diversification.

Can I Get Monthly Income From Mutual Funds? 

The best approach to earn you a stable monthly income is setting up a Monthly Income Plan (MIP) mutual fund. The fund falls under a debt or hybrid fund. It allows investors to receive monthly dividends payout while reducing their risk exposure. Typically, the fund is more conservative since only a small percentage goes to stock while a bigger portion goes to secure securities.

While comparing it to other financial instruments with a similar target, like FDs and PPFs, MIP offers more stable returns during inflation. In addition, they attract lower taxation. However, MIPs are not guaranteed to yield consistent fixed monthly income. The fund, like any other portfolio, has its downsides. For instance, in case of economic instability, your fund may not pay consistent monthly dividends.

Can I Lose Money in Mutual Funds? 

Investing in a mutual fund is not a guarantee you will gain a lucrative return from your investment. Even the safest funds attract a certain level of risk. Factors like prevailing economic conditions impact the volatility of the fund. Poor or good management is also another vital element that hugely affects returns.

However, there are certain things you can do to select a safer mutual fund. To begin with, you should to buy your mutual fund from a reputable broker. Also, take your time to study the past performance of the mutual fund before tossing in your coin.

Things To Consider When Choosing Mutual Fund

There are certain general guidelines that mutual funds investors should follow when choosing a mutual fund.

The fund has to align with your long-term financial plan. That means the fund has to offer not only reasonable returns but also relatively low risks.  You have to watch for a performing fund. Ensure the history of the fund does not falter to volatility. You have to tie this to a consistent return for at least 3-years.  For a fair deal, the terms should be open and not left to the discretion of the fund managers. Also, the discipline and reputation of the management team should be intact.

And when looking for the best company, ensure they offer the no-load funds. Cutting down your expenses on broker fees and sales charges will provide you an opportunity to make a reasonable return from your investment.

Risk Tolerance

Assessing risk tolerance is the first step in establishing the acceptability of any investment product. This is the ability and motivation to take on risk in exchange for a higher chance of profit. Though mutual funds are frequently regarded as one of the safest investments available, certain types of mutual funds are not ideal for investors who want to avoid losses at all costs.

Investors with very low risk tolerances, for example, should avoid aggressive stock funds. To create bigger returns, some high-yield bond funds may also be too hazardous if they invest in low-rated or trash bonds.

Active or Passive?

An active mutual fund refers to a fund management style that is actively involved in buying and selling. Fund managers engage in short bursts investments motivated by the current market position, gut feeling, or world events. On the positive side, they can yield high returns, offer flexibility, and present more investment options. However, it suffers drawbacks like high risks level, is effort-intensive, and attracts high brokerage costs.

Passive mutual funds, in contrast, is a fund management strategy where the broker tends to be long-term oriented and non-assertive, unlike active mutual funds. They build the portfolio and hold. On the positive side, they are way easier to manage, have low risk, and attract few expenses. However, since they are long-term oriented, they can suffer from short-term price drops.

Your Personal Targets

Another significant factor to consider when evaluating the suitability of mutual funds is your individual investment goals, which may make some mutual funds more suited than others.

High-risk funds are not a suitable choice for an investor whose main purpose is to conserve wealth, which means she is ready to accept smaller gains in exchange for the assurance of knowing her initial investment is safe. Most stock funds and many more aggressive bond funds should be avoided by this sort of investor since they have a very low risk tolerance. Instead, look into bond funds or money market funds that solely invest in highly rated government or corporate bonds.

How to Compare Funds

It's time to evaluate your mutual fund possibilities once you've figured out your investing approach. Many fund screeners are accessible on the internet to help you find and investigate mutual funds, including a screener that allows you to look for mutual funds based on asset class or risk profile. A list of mutual fund options that you can buy in your 401(k) or IRA account may be provided by your 401(k) or IRA provider.

It's vital to look at a mutual fund's history and how it's fared over the last 10 to 20 years, not just the last year or two, when making a decision. It's easy to have tunnel vision and focus just on funds that have delivered excellent returns in previous years. Take a deep breath, take a step back, and look at the larger picture instead.

You'll also want to know how the mutual fund has done over time in comparison to other similar funds in the market. Is it at least keeping up with a good benchmark like the S&P 500, or has it been performing so poorly that even the “worst” funds appear to be performing well? Overall, you want to buy a fund with a long track record of excellent returns to reduce your risk.

Tax Planning

Taxes must be considered while evaluating the suitability of mutual funds. Mutual fund income, depending on an investor's present financial condition, might have a significant impact on an investor's annual tax liability. The higher your ordinary income and capital gains tax bands are in a given year, the more money you make.

For those wanting to reduce their tax liability, dividend-bearing ETFs are a terrible choice. Though long-term investment funds may pay eligible dividends that are taxed at a lower capital gains rate, any dividend payments raise an investor's taxable income for the year.

The ideal option is to invest in funds that focus on long-term capital gains rather than dividend equities or corporate bonds that provide interest. Interest earned by funds that invest in tax-free government or municipal bonds is not subject to federal income tax. As a result, these goods could be an excellent option. However, not all tax-free bonds are entirely tax-free, so check to see if any earnings are subject to state or local taxes.

Are Mutual Funds Safer than Stocks? 

Admittedly, mutual funds attract low risks, but also, they earn low-medium yields. On the downside, they come with higher fees than stocks. In comparison, stocks are riskier, but their reward is potentially medium to high. Their investment implication is in ownership of a company. Meaning, if the company grows to a behemoth, so do the shares.

The fund managers of a mutual fund do not necessarily invest in shares. They diversify the portfolio to bonds or other debt securities to shield investors from adverse risks. As an investor, you have to evaluate your risk tolerance versus your income goal. Generally, if you have a low-risk tolerance, a mutual fund is a better option. However, if your goal is a higher reward without being bothered by the risk level, invest in stocks.

Mutual Fund Fees

According to the SEC, there are two types of fees and expenses:

The first category is called “Shareholder Fees,” and it includes all fees associated with purchasing, selling, or exchanging mutual funds. They could include things like front- and back-end sales loads, redemption fees, and so on.

The “Operating Costs,” which result from the management of your account, are the second major group. They come in a variety of forms, including administration and distribution fees, as well as other costs.

  • Front-End Sales Loads – When an investor buys shares through a broker or a financial advisor, they pay a fee for their services. This fee usually ranges between 5% and 8.5 percent (the Financial Industry Regulatory Authority does not allow sale loads to exceed 8.5 percent ). Assume your original investment is $5,000 and the front load is 6%, which means the sales commission you must pay the mutual fund is $300 percent. This brings your total investment to $4,700.
  • Back-End Sales Loads – This form of fee is only applied when an investor sells his or her stock. The amount of back-end sales burden is usually expressed as a percentage of the share value. For example, if you invest $5,000 in a mutual fund with a 6% back-end sales load, you will have $5,000 to buy the fund's shares. If you sell the stock, the fund will charge you the fee.
  • Redemption Fees – When investors redeem their shares in some mutual funds, they may be charged a fee. It's usually a proportion of the redemption price, with the goal of discouraging traders from making short-term investments. These costs, unlike back-end loads, which are used to pay a broker's commission, are returned to the fund.
  • Other Shareholder Fees – Account fees, purchase fees, and exchange costs are examples of other shareholder fees. Some funds charge an account fee to keep your account active. When an investor transfers shares from one mutual fund to another, most mutual funds impose an exchange fee. When a trader buys shares from the funds, they must pay purchase costs. The difference between this fee and a front-end load is that the former goes to the fund, while the latter goes to the broker.
  • Management Fee – All mutual funds employ a team of professionals and advisers, and you, as an investor, should compensate them for their efforts in researching and selecting the best assets, as well as managing the whole investment portfolio. Each fund has a management charge, which is typically a percentage of the fund's total value. The management charge typically ranges from 0.10 percent to 2%.

Conclusion

There's no denying that there are some disadvantages and risks associated with mutual funds. For example, though it's convenient and is quite an attractive opportunity, you have no control over your investments. Once in a fund, the manager will do what they think best.

Despite that, mutual funds are very simple, easy to use and convenient for individual investors. In addition, they are affordable (50USD and you are in) and offer you the chance to create a diversified portfolio. For example, if you wish to achieve that on your own, it would perhaps take you a long period of time and a great deal of money.

On balance, it's safe to say that mutual funds are a great investment opportunity, especially for people who feel like fish out of water when it comes to markets. When investing in mutual funds, a person should always set his goals first and think carefully about what kind of strategy they would like to employ. Then it's simple, you just find the right fund for you and go ahead. 

FAQs

Rather of buying from other investors, investors purchase mutual fund shares directly from the fund or through a fund broker. The fund's per share net asset value plus any fees payable at the time of purchase, such as sales loads, is the price that investors pay for the mutual fund.

Shares in mutual funds are “redeemable,” which means that investors can sell them back to the fund at any time. In most cases, the fund is required to provide you the payment within seven days.

The immediate outcome of a market crash to mutual funds is a drastic reduction of investment income. The returns earned from your mutual funds will take a hit, and the streams will decline or dry up. Though bonds and debt securities have a high tolerance to risk, they will equally feel the pinch but not as hard as stocks. To shield yourself from these adverse effects, you should ditch leveraged funds, spread your risks through diversification, invest in bonds funds, or even invest in noncyclical funds, among other tactics.

As a beginner mutual fund investor, you must first determine your investment horizon and the amount of risk you are willing to take. For a start, a novice investor should consider investing in mutual funds that are no-load and low-cost. No load mutual funds are inexpensive, since they do not charge broker commissions to investors, and you get to keep most of the returns earned.

Index funds are also a good pick for beginner investors, since they are selected to mimic large funds such as the S&P 500, hence they can help novice investors diversify their portfolio. Before investing in a specific fund, an investor must conduct due diligence and compare several funds to choose funds that align with their overall investment goals.

Generally, there are 5-popular mutual funds evaluations strategies

The first strategy involves understanding the mutual fund holding. This strategy helps investors understand the fund strategy. 

Also, you should understand the expense ratios or loads fees of the fund. The expense ratios show the percentage cost of investing in the fund. The loads, in comparison, are transactional fees charged by the broker. 

Besides, you must understand the investment strategy of the fund. This helps investors to decide whether to invest in a fund or not depending on their individual goals.

Another significant element in evaluation is the management style of the fund. Here, the available options are between a passive or an active mutual fund. 

The last strategy involves comparing the performance of the fund against different benchmarks and competitors. Though not future-proof, it is a must-have tool.