On a similar note...
On a similar note...
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What is a mutual fund?
Mutual funds pool money from investors to purchase stocks, bonds and other assets to create a diversified portfolio beyond what the average investor can build on their own: Rather than buy individual securities, professional fund managers do it for you.
Mutual fund investors own shares in a company whose business is buying shares in other companies (or in government bonds, or other securities). Mutual fund investors don’t directly own the stock in the companies the fund purchases, but share equally in the profits or losses of the fund’s total holdings — hence the “mutual” in “mutual funds."
Investors buy shares that rise or fall in value based on the performance of the fund’s underlying securities. Mutual fund share purchases are final after the close of market, when the total value of the underlying assets are valued. The price per mutual fund share is known as its net asset value, or NAV.
Buying a mutual fund in 5 steps
Decide whether to go active or passive. Costs and performance often favor passive investing.
Calculate your budget. Different mutual funds have different minimum investments, so this can help decide which mutual fund to buy..
Decide where to buy mutual funds. Find the right broker that offers the right fund for your budget.
Understand and scrutinize fees. A broker that offers no-transaction-fee mutual funds can help cut costs.
Build and manage your portfolio. Check in on and rebalance your mix of assets once a year.
Step 1. Decide whether to go active or passive
Your first choice is perhaps the biggest: Do you want to beat the market or try to mimic it? It's also a fairly easy choice: One approach costs more than the other, often without delivering better results.
Actively managed funds are managed by professionals who research what's out there and buy with an eye toward beating the market. While some fund managers might achieve this in the short term, it has proved difficult to outperform the market over the long term and on a regular basis. These funds are more expensive because of the human touch involved.
A more hands-off approach called passive investing is rising in popularity, thanks in large part to the ease of the process and the results it delivers. Passive investing is best for most people because the funds are cheaper and there are fewer fees.
Perhaps the signature passive investment is the index fund, which buys a basket of securities meant to represent an entire market. For example, the holdings in a Standard & Poor's 500 fund mirror those in the popular index of 500 stocks, and the fund's performance is meant to replicate the performance of the index itself.
So when you hear that the S&P 500 was up 3% for the day, that means your index fund was up, too. And since there's no real management going on, its fees are lower than for an actively managed fund.
» Want to know about passive investing involving robo-advisors? Learn more about this automated way to manage your portfolio
Step 2. Calculate your budget
Thinking about your budget in two ways can help determine how to proceed:
How much do I need to get started? Mutual fund providers often require a minimum amount to open an account and begin investing. Some brokers have no account minimum; others can range from $500 to $3,000.
How should I invest that money? As mentioned earlier, the great advantage of mutual funds is the low-cost way they offer to build a diverse portfolio across stocks (for growth) and bonds (for lower but steadier returns). But what initial mix of funds is right for you?
Generally speaking, the closer you are to retirement age, the more holdings in conservative investments you will want to have — younger investors have more time to ride out riskier bets and inevitable reversals. One kind of mutual fund takes the guesswork out of the “what's my mix” question: target-date funds, which automatically reallocate your asset mix as you age.
» Have a small amount to work with? Here's how to invest $500
Step 3. Decide where to buy mutual funds
You need a brokerage account when investing in stocks, but you have a few options with mutual funds. If you contribute to an employer-sponsored retirement account, such as a 401(k), there’s a good chance you’re already invested in mutual funds.
You also can buy directly from the company that created the fund, such as Vanguard or BlackRock Funds. But each of these options may have a limited choice of funds.
Most investors would be wise to buy from an online brokerage, many of which offer a broad selection of mutual funds across a range of fund companies. If you go with a broker, you'll want to consider:
Affordability. Mutual fund investors can face two kinds of fees: from their brokerage account (transaction fees) and from the funds themselves (expense ratios and front- and back-end “sales loads”). More on these below.
Fund choices. Workplace retirement plans may carry only a dozen or so mutual funds. You may want more variety than that. Some brokers offer hundreds, even thousands, of no-transaction-fee funds to choose from. There are many other types of funds available, such as exchange-traded funds, or ETFs, which offer the diversification benefits of mutual funds but can be traded like individual stocks; and target-date funds, which invest in other mutual funds and reallocate their assets to become more conservative over time.
Research and educational tools. With more choice comes the need for more thinking and research. It's vital to pick a broker that helps you learn more about a fund before investing your money.
Ease of use. A brokerage's website or app won't be helpful if you can't make heads or tails of it. You want to understand and feel comfortable with the experience.
» Learn more: Understand the different types of mutual funds
Step 4. Understand and scrutinize mutual fund fees
Back to the active-versus-passive question: Generally speaking, the service level of actively managed accounts will be higher, but so will the fees you pay.
» How do fees impact returns? This mutual fund calculator can help
Either way, a company will charge an annual fee for fund management and other costs of running the fund, expressed as a percentage of the cash you invest, known as the expense ratio. For example, a fund with a 1% expense ratio will cost you $10 for every $1,000 you invest.
These fees aren't always easy to identify upfront, but it's well worth the effort to understand, because they can eat into your returns over time.
Another common expense are sales loads. These are commissions paid at the time of share purchase (front-end loads) and when redeemed (back-end loads). Sales loads are compensation paid to financial professionals, such as a broker or investment advisor, to buy mutual fund shares.
Step 5. Build and manage your portfolio
Once you determine the mutual funds you want to buy, you'll want to think about how to manage your investment.
One smart move would be to rebalance your portfolio once a year, with the goal of keeping it in line with your diversification plan. For example, if one slice of your investments had great gains and now constitutes a bigger share of the pie, you might consider selling off some of the gains and investing in another slice to regain balance.
Sticking to your plan also will keep you from chasing performance. This is a risk for fund investors (and stock pickers) who want to get in on a fund after reading how well it did last year. But "past performance is no guarantee of future performance" — and it's an investing cliché for a reason. It doesn't mean you should just stay put in a fund — go on, shop the funds offered by your broker to see if you can find something similar for less — but chasing performance almost never works out.
» Ready to go? Here's our roundup of the best brokers for mutual funds
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