What Is A Mutual Fund and How To Invest In Them Successfully

Many people don’t even know what is a mutual fund, let alone investing in them. If you are one of them, don’t worry because you are going to learn everything about them. A mutual fund is an investment firm run by professional money managers. They collect money from thousands of investors like you, and then wisely put that money in various investments such as stocks, bonds, futures, money market funds to create a portfolio. Mutual funds put your money in different baskets, thus minimizing the risk.

When you purchase stocks, you own a part of the company. Similarly, when you invest in a mutual fund, you’ll become a “shareholder” in the mutual fund company. When the mutual fund makes money, you’ll get dividends (profits on the money you have invested). However, the value of your shares will decline in case there are losses.

Open-ended vs. Closed-ended Funds

Mutual funds are of two types – open-ended and closed-ended. The open-ended funds are further subdivided into load and no-load funds.

A large number of mutual funds are open-ended, i.e., they issue shares whenever an investor wants them and redeem the shares if an investor decides to sell. Since the shares are issued and redeemed as necessary, they reflect the actual value of the fund.

Contrary to open-ended, closed-ended funds have a set number of shares issued for public in stock exchanges. These shares can be purchased or sold in the open market. Closed-ended funds do not issue new shares or redeem as necessary. Therefore, their prices are based on the law of supply and demand.

We discussed that open-ended funds are of two types. Loads and non-loads. Simply put, load is sales commission added to the mutual fund share prices when you purchase it. Usually it is charged by the fund sales person, and can go up to 8.5 percent of the sales prices.

Most of the mutual funds are no-load type. That means you won’t have to pay any sales fee to anybody. The mutual fund directly markets to potential investors, so there is no sales person involved. No-load funds generally yield better returns because they carry lower expenses.

Benefits of Investing In Mutual Funds

Well, the biggest benefit is that it heavily minimizes the risk. Investors who don’t know much about the stock market or money management can put their money in the hands of some reliable, professional money managers. Mutual funds constantly monitor every investment in their portfolio, and they buy or sell whenever the time is appropriate.

Additionally, they devote much more amount of time on selecting investments than any individual investor. Investing without calculating the financial ratios or analyzing the security give you peace of mind, and provides you the opportunity to spend your time on something you love.

Since the compensation of money managers at a mutual fund is directly tied to performance of the fund, they always ensure an effective growth.

How To Choose The Right Mutual Fund

When looking for a mutual fund that fits your portfolio, you have to consider three things: your purpose behind investing, investing style and risk tolerance. Some people invest to buy a new home in the future or for retirement purpose. Your purpose of investment and the kind of returns you expect will define the risk tolerance. Everybody has a different investing style and strategy. Some like investing in start-ups, others invest only in blue chip companies or s specific sector.

Once you choose a mutual fund, go to S&P or Morningstar. I personally prefer the data from Bloomberg. They rank mutual funds based on their past records. You can rely on the rankings, but be careful if the fund manager has changed recently at the mutual fund of your choice.

You should be aware of the factors that will help a particular mutual fund perform better in the future, and why it should be a part of your portfolio. The technique I use to know these things is that I simply ask fund managers what is the position of their current portfolio and how they plan to outperform in the future.

How To Invest In Mutual Funds

People with a brokerage account can purchase shares of a mutual fund just like they do for stock purchasing. If you don’t have a brokerage account, don’t panic. You can directly contact the mutual fund to request information and application form, or visit their website.

Usually, mutual funds put a minimum limit on initial investment. It varies widely from $25 to as much as $100,000, but most of them are in the range of $1,000-$5,000. Mutual funds have made investing very easy with multiple payment options and a minimum amount of paperwork.

Can you add something to the list? If you are an experienced mutual fund investor, how did you get started? Enlighten our readers with your story.

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