A Mutual Fund is a pool of money that is managed by a group of professional money managers. These money managers accept investor’s money, pool it together, and invest it in a portfolio of stocks, bonds, and cash. A mutual fund is an easy way to invest your money and can be started with as little as $25 a month. Low contributions to get started makes it possible for small investors, with little cash to invest, to experience and benefit from being in the market. You can also set up a direct deposit from your bank account to a mutual fund for an easy way to invest your money on a monthly basis automatically.
Mutual Funds usually try to perform to a benchmark i.e. a market index. For example, a mutual fund might try to match the return of the S&P 500 Index. The S&P 500 Index is an index that measures the price of the 500 largest publicly traded companies in the U.S. If the money managers want to benchmark to the S&P 500 Index, they would want to buy shares in the 500 largest stocks, i.e mimicking the S&P 500 Index. Get it? Other mutual funds benchmark to other indexes.
Why Invest in a Mutual Fund?
If you know little about investing, a mutual fund may be right for you. Mutual funds are professionally managed, meaning your money will be properly invested and diversified to reduce your risk without any work from you. In this scenario, a financial planner will most likely help you find a fund that works for you.
Here are some pros of investing in a mutual fund:
- Easy and affordable to invest in
- Your money is professionally managed
- Numerous styles of mutual funds to match your preference
Which mutual fund is right for me?
Your situation, age, and risk preference will determine which type of mutual fund is right for you. If you’re younger, you can afford to take on extra risk to receive higher returns. On the other hand if your older, you’d be safer investing in less risky investments in case you need the money in your retirement years. A mutual fund is as risky as the stocks/bonds that make up the fund.
Mutual fund fees: Beware of what fees you are being charged
In many cases a mutual fund will not perform to the desired market index benchmark – the gap between the benchmark return and actual return tends to equal the fees being charged by the money managers. Some better funds are internally efficient and have low operation expenses meaning lower fees for you. While other mutual funds may end up having bad management practices and higher fees because they are not as internally efficient! This means you are paying the bad managers more and receiving less in returns!
If you are picking between two mutual funds that are invested in mostly the same stocks/bonds/etc., pick the one with lower fees – Why would you pay more in fees to own essentially the same investment??
A new trend starting to outpace mutual funds are index funds – similar to a mutual fund with a lot less expenses. Learn more about Index Funds with my article Index Funds: Beating Your Mutual Funds Return.