Mutual Funds For Beginners

Mutual Funds are a great way for beginners to get started investing and build their retirement portfolio. The problem is that most beginner investors don’t understand what are mutual funds are and how they work. In this tutorial we will take a look at all of the mutual fund basics and walk you through the various types of mutual funds, how to find mutual fund quotes and gauge their performance. Let’s get started shall we?

What are Mutual Funds? Mutual Fund Definition

Mutual funds can be a little confusing but the best analogy I can make is mutual funds are essentially an investment pie. They are a group of other investments all baked in to one fund and divided up in to equal shares depending on how much you invested. If this is confusing let’s start from the beginning.

When a company like TRowe Price or Vanguard puts together a mutual fund they collect money from investors until it reaches a certain amount. For this example let’s say $100 million combined from all investors. The mutual fund company will then invest that money according to the basic terms of what the investors agreed upon. Depending on the fund this money could be invested in stocks, bonds, treasury bills, money market funds, emerging market stocks… you get the idea. Once the money is all invested the mutual fund is divided in to shares and distributed back to the investors according to how much each person invested in the fund.

Types of Mutual Funds

There are literally thousands of types of mutual funds out there, enough that every investor can find a type of fund that is right for them. Investopedia sums the types of mutual funds up well saying that they fall in three classes… money market mutual funds, fixed income or bond mutual funds or equity / stock mutual funds.

Money market mutual funds are funds invested in very low risk investment products, and they provide only small returns but they are very low risk. These types of mutual funds would be ideal for an investor that is close to retirement and is worried about losing their nest egg only months or years before retirement. You can find a lot of government backed treasury bills and bonds in this type of investment primarily so the return won’t be great, but unless the government goes under they should be very low risk.

Bond funds or fixed income mutual funds are essentially mutual funds that invest in bonds (hence the name). Since bonds provide a fixed rate of return to their investors bond funds do as well. Most fixed income funds will contain a nice mix of bonds of various financial ratings (from companies like moodys or standard and poors) to diversify risk should any of these companies go under. Depending on the risk level of the company (poor ratings) the bonds will pay a higher return to make the risk worth it for the investors. Bond funds will contain a mix according to the risk tolerance of the investors so you should be able to find a bond fund that pays enough return for just about every investor.

The most common type of mutual funds are equity funds which typically contain a mix of stocks primarily, with a mix of bonds and money markets with the remaining portion of the fund. Equity funds are a nice way for investors who want to diversify their portfolio but don’t have the capital to run out and buy lots of individual stocks. By buying in to equity mutual funds these investors get the benefits of a diversified group of stocks, but also get the benefit of investing a smaller amount of money. The primary benefit of these growth stock mutual funds is to obtain capital gains over time which will improve the overall value of the funds.

Within the equity fund category you can find a variety of risk levels and/or types of investments. For example you can buy riskier mutual funds like emerging market funds that pay a really high return but have a great deal of risk, or you could buy a fund made up of blue chip stocks that move very slowly and have a history of small but steady returns. You can even buy funds that consist of companies with a common goal such as green mutual funds. Typically most funds will invest in a combination of all of these types of investments so you should always make sure you understand what the underlying investments are before investing your hard earned cash.

One thing to keep in mind that just because a fund is in a similar grouping, doesn’t mean that they are the same. For example a conservative bond fund from one company might be 75% invested in treasury bonds while another might be only 60% invested. This is why it is important to read the mutual fund prospectus and understand what type of investments are involved and to look at the mutual fund performance over time to see what kind of return it has brought historically.

Mutual Fund Advantages

Inexpensive. There are a number of advantages for investing in mutual funds. First of all they are affordable for the common investor. When you invest in stocks you will need enough money to buy at least one share and for some companies that can be hundreds or thousands of dollars per share. You can invest virtually any amount of money in mutual funds (per the issuing company’s rules of course).

Diversification. As mentioned, mutual funds provide a simple method of diversification or investing money in different types of securities and different types of companies so all of your investment eggs aren’t in one basket. Diversifying your portfolio can be tricky on a fixed budget so mutual funds give you an inexpensive way to protect your investment.

Experienced management. Mutual funds are managed by a fund manager that decides what investments should be bought and sold on behalf of the fund. Most investors that are reading this article have little to no experience investing in the market and may not be ready to make investment decision on their own. Even though mutual funds can and do lose money, having an experienced fund manager manage your money will greatly eliminate some market risk.

Mutual Fund Disadvantages

Fees and expenses. Mutual funds charge a wide variety of fees and expenses so before you invest in any of them you need to be 100% sure you understand them all and how they impact your rate of return. Some funds may charge an annual maintenance fee while others may charge a fee whenever the fund manager makes a trade. Before investing based on the historical rate of return on the fund, be sure you understand how the fees and expenses will eat away at that return.

Lack of Investment Control. As mentioned in the mutual fund advantages section, having someone else decide what securities you should buy and sell takes control out of your hands. As you become a more experienced investor you may decide that you want to take control of your investments and manage them on your own.

The bottom line when it comes to mutual fund investing is that they are a good way to start investing, especially if you have a limited amount of capital to invest. No matter how much you have to invest and what type of investments you are looking for there is probably a mutual fund that is right for you. As always be sure to check with your financial advisor to be certain mutual fund investing is right for you and make sure you read and understand all the fees, expenses, terms and conditions involved before you buy mutual funds.

© Mutual Funds For Beginners

Related posts:

1. What are Bond Mutual Funds? Types of Bond Funds
2. Investing in Stock Funds: Equity Mutual Funds
3. Are mutual funds a good investment?