Depending on your financial goals, mutual funds can be an essential tool for achieving long-term wealth. Although they tend to have higher fees and higher investment requirements than exchange traded funds, their heirloom status appeals to many investors.
What is a mutual fund and why should you consider investing in it?
Mutual funds are investment vehicles that allow you to hold a portfolio of stocks, bonds, or other securities. When you buy a unit of a mutual fund, you own a tiny fraction of all the assets in that fund.
For retail investors, the most common reason to buy mutual funds is for diversification. Owning a variety of investments minimizes the risk of having too much exposure to a single asset.
For example, when the stock market goes down, safe haven assets like gold or bonds tend to go up. A well-diversified portfolio gives you peace of mind, especially if your goal is to build wealth over time.
Besides diversification, mutual funds are a profitable way to streamline the investment process. With these managed funds, you let a professional do the work for you.
Actively managed funds vs. passively managed funds
Mutual funds can be classified as passively or actively managed.
In a passive management strategy, a fund manager aims to replicate the performance of a broad benchmark like the S&P 500. With one of these investments, you essentially own all of the stocks that make up the index. This process eliminates the need for fund managers to select individual companies at their discretion. As a result, the management fees are generally low.
With actively managed funds, fund managers buy and sell assets when they find an opportunity, as long as those investments align with the fund’s strategy. The objective here is to produce higher returns than one would obtain by simply following an index. As a result, these funds generally have higher fees and may exhibit greater volatility than passively managed funds.
The key when building your portfolio is to keep fees low and stay diversified. The more you can minimize unnecessary spending, the more you can invest in your financial future.
How to invest in mutual funds?
For the independent investor, the purchase of mutual funds can be done at low cost or at no cost.
Automated investing has also made it easier to buy mutual funds. Robo-advisers automatically realign asset allocations as part of their service based on investor profiles.
Many investors are still more comfortable working with a financial advisor. Of course, this personalized attention can pay off. Nonetheless, many brokers offer free resources, which may include free consultations with a financial planner.
When you are ready to invest in mutual funds, be sure to check if there are minimum initial investment requirements, the types of operating expenses you will pay and the clauses related to the withdrawal of the money. .
For example, some mutual funds have early redemption fees or even load fees. Loading fees are a commission that an investor pays when buying or selling mutual funds. Mutual fund companies and their intermediaries determine these fees.
In the long run, fees are a key consideration for investors because they reduce your returns.
All the information you need about a specific fund is available in the fund prospectus. Take the time to review it in detail and make sure you are comfortable with all of the conditions.
As with most investments, mutual funds are susceptible to losses. The magnitude of potential losses is linked to the level of risk contained in the portfolio. Thus, a fund that invests heavily in riskier assets like emerging technologies will have a very different risk profile than a fund that invests in established and proven names.
Before you get started, here are four steps to follow:
- Determine your financial goals: The type of investment you choose depends on what you are trying to achieve. For example, someone who is about to retire will likely have a different asset mix than someone who has just graduated from college. So always let your financial goals guide your decision making.
- Research on mutuals: When selecting mutual funds, pay attention to factors such as expense ratios, past performance of the fund, trading volume, major holdings, fund flow, and net asset value.
- Describe your asset mix: Before investing, take an inventory of what you own and how you want to allocate your assets. Remember that a key is to stay diverse.
- Know what you have: By periodically reviewing your investments, you can take charge of your finances and make the necessary adjustments. Use all of your broker’s free resources, like meeting with a financial planner, and always ask questions. Ultimately, investing without intervention does not exist.
Types of mutual funds
There is an abundance of mutual fund categories available for retail investors. These are designed to help you achieve different financial goals, such as retirement.
Below are some of the main categories that fund investors can choose from:
Equity funds
These funds invest in national or foreign stocks. Some follow a broad benchmark in a passive management strategy, while others are actively managed, relying on a fund manager’s ability to select stocks. In general, they are classified according to an investment style such as growth or value. Company size also plays a role, with large cap companies having more established profiles than small and mid cap companies.
Bond funds
One of the most popular types of mutual funds, bond funds invest in many different individual bonds, and income payments are usually made monthly. Bond funds can also be classified according to the type of bonds in which they invest, for example government or corporate debt. Considered a safer investment than equity funds, bond funds offer better returns than standard savings accounts.
Index funds
These funds aim to replicate the performance of a broad benchmark such as the S&P 500 or the Nasdaq 100. Index funds offer instant diversification and often have lower fees than actively managed funds. In addition, these investments do not rely on the ability of a fund manager to select winning stocks. The mantra of index investors is “If you can’t beat them, join them”.
Money market funds
Considered low risk, these funds typically invest in US Treasuries, certificates of deposit (CDs) and other cash equivalents. They offer better returns than your typical savings account, but your investment is not insured by the Federal Deposit Insurance Corporation (FDIC).
Balanced funds
Through this investment, you have access to a mix of stocks, bonds and money market funds. Also known as asset allocation funds, they offer tailored strategies aimed at delivering a combination of growth and income.
Target date funds
These managed funds change their asset allocations based on your expected retirement age, selecting more conservative assets as you get older. The key with target date funds, and any other funds for that matter, is to review the contents of the fund and make sure the strategy aligns with your financial goals.
At the end of the line
Mutual funds can help you reach your investment goals. There are many reasons to own them, including diversification and convenient access to a variety of investment strategies.
