Mutual Funds 101

mutual-fund.jpgBuying a mutual fund may be the smartest decision you can ever make , however with over 12,000 mutual funds to choose from, it can also be your worst if you don’t know what your doing. If you’re thinking to invest in a mutual fund, then you’re in the right process of thinking, but you have to make sure that you do your research first. There are some things you should know before you get into investing in funds.

Things to know:
1.) What is a Mutual fund
2.) Different kinds of stock funds
3.) Importance of low expenses
4.) Don’t go after the “winners”
5.) Don’t be too quick to dump a fund
6.) Be aware of taxes

1.) A mutual fund is simply a collection of stocks and/or bonds. A mutual fund pools money from hundreds and thousands of investors to construct a portfolio of stocks, bonds, real estate or other securities, according to its charter. Each investor in the fund gets a slice of the total pie.

2.) The different kinds of stock funds includes growth funds, which buy shares of burgeoning companies; sector funds, which buy shares of companies in a particular sector such as technology or health care; and index funds, which buy shares of every stock in a particular index, such as the S&P 500.

3.) The importance of low expenses are crucial when looking for a fund. Companies add on these expenses to cover their expenses and to make profit of course so watch out for these. They don’t charge more a few percentage points a year, expenses may not sound substantial, but they create a serious drag on performance over time.

4.) Don’t go after the winners because stats show that funds that rank very highly over one period of time rarely finishes on top in the later ones. When choosing a fund, do some research and look for consistent long term results.

5.) Don’t be quick to dump a fund because every fund will have its off year. If you find your fund to be losing a little here and there don’t be so quick to dump it. Although you may be tempted to sell a losing fund, check to see its previous behaviors and see if whether it has trailed comparable funds for more than two years. If it hasn’t then be patient. However if earnings have been consistently below par, it may be time to move on.

6.) Be aware of taxes even if you don’t sell your fund shares, you could still end up stuck with a big tax bite. If a fund owns dividend-paying stocks, or if a fund manager sells some big winners, shareholders will owe their share of Uncle Sam’s bill. Tax-efficient funds avoid rapid trading (and high short-term capital gains taxes) and match winning trades with losing trades. Also don’t double pay your taxes!
Now here are some advantages and disadvantages of mutual funds:

Advantages:

  • Low start -You can get started for as little as $100, but 2000 – 3000 is the common minimum.
  • Diversification- Buying a mutual fund provides instant holdings of several different companies.
  • Liquidity- Like individual stocks, a mutual fund investment can be converted into cash upon your request, in other words, it gives you convenient access to your money.

Disadvantages:

  • The Wisdom of Professional Management- That’s right, this is not an advantage. The average mutual fund manager is no better at picking stocks than the average nonprofessional, but will charge you fees as though he/she is.
  • No Control- Unlike picking your own individual stocks, a mutual fund puts you in the passenger seat of somebody else’s car.
  • Dilution- Mutual funds generally have such small holdings of so many different stocks that insanely great performance by a fund’s top holdings still doesn’t make much of a difference in a mutual fund’s total performance.
  • Buried Costs- Many mutual funds specialize in burying their costs and in hiring salesmen who do not make those costs clear to their clients.

The key thing is to research research and research. You want to have a very good understanding of how all the fees work and review their prospectus. Their Prospectus should provide things such as fees, objectives, risks, etc. All in all, study and know what your putting your money into. There are many websites with very useful information and here are some that are updated pretty frequently. Have fun!

  1. very well written. thanks for providing a succinct and easy to understand primer.

  2. Very good information about mutual funds.

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