How To Invest in Mutual Funds

To invest in mutual funds, you'll want to decide what type of funds match your goals, choose an online brokerage account and research your options, being careful to consider and understand fees.
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how to invest in mutual funds

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Mutual funds are the bedrock of many investment accounts, especially retirement accounts like 401(k)s. Investing in mutual funds is popular in part because they're a relatively hands-off way to invest in many different assets at once — within a single mutual fund, you could gain exposure to hundreds of stocks, bonds or other investments.

Mutual funds are an especially common investment for investors who don't want to pick and choose individual investments themselves, but want to benefit from the stock market's historically high average annual returns.

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How to invest in mutual funds

If you're ready to invest in mutual funds, here is our step-by-step guide on how to buy them.

1. Decide whether you want to invest in active or passive funds

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.

Passive investing is a more hands-off approach and is rising in popularity, thanks in large part to the ease of the process and the results it can deliver. Passive investing often entails fewer fees than active investing. Many passive investors choose index funds or ETFs, which are similar to mutual funds but they aren't professionally managed. This often means they carry lower fees.

2. Calculate your investing budget

Thinking about your budget in two ways can help determine how to proceed:

How much do mutual funds cost? One appealing thing about mutual funds is that once you meet the minimum investment amount, you can often choose how much money you’d like to invest. Many mutual fund minimums range from $500 to $3,000, though some are in the $100 range and there are a few that have a $0 minimum. So if you choose a fund with a $100 minimum, and you invest that amount, afterward you may be able to opt to contribute as much or as little as you want. If you choose a fund with a $0 minimum, you could invest in a mutual fund for as little as $1.

Aside from the required initial investment, ask yourself how much money you have to comfortably invest and then choose an amount.

Which mutual funds should you invest in? Maybe you’ve decided to invest in mutual funds. 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 may want to have — younger investors typically have more time to ride out riskier assets and the inevitable downturns that happen in the market. 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.

» What’s the right number of funds? Here’s our guide to how many funds to buy

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 could buy directly from the company that created the fund, such as Vanguard or BlackRock, but doing so will limit your choice of funds. You can also work with a traditional financial advisor to purchase funds, but it may incur some additional fees.

Most investors opt to buy mutual funds through an online brokerage, many of which offer a broad selection of 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, as well as other types of funds like ETFs.

  • 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.

» NerdWallet's roundup of the best brokers for mutual funds

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4. Understand mutual fund fees

Whether you choose active or passive funds, 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 and known as the expense ratio. For example, a fund with a 1% expense ratio will cost you $10 for every $1,000 you invest.

A fund’s expense ratio isn’t always easy to identify upfront (you may have to dig through a fund’s prospectus to find it), but it's well worth the effort to understand, because these fees can eat into your returns over time.

» How do fees impact returns? Use our mutual fund calculator to find out

Mutual funds come in different structures that can impact costs:

  • Open-end funds: Most mutual funds are this variety, where there is no limit to the number of investors or shares. The NAV per share rises and falls with the value of the fund.

  • Closed-end funds: These funds have a limited number of shares offered during an initial public offering, much as a company would. There are far fewer closed-end funds on the market compared with open-end funds. A closed-end fund’s trading price is quoted throughout the day on a stock exchange. That price may be higher or lower than the fund’s actual value.

Whether or not funds carry commissions is expressed by “loads,” such as:

  • Load funds: Mutual funds that pay a sales charge or commission to the broker or salesperson who sold the fund, which is typically passed on to the investor.

  • No-load funds: Also known as “no-transaction-fee funds,” these mutual funds charge no sales commissions for the purchase or sale of a fund share. This is the best deal for investors, and online brokers often have thousands of choices for no-transaction-fee mutual funds. Most funds available to individual investors are currently no-load.

5. Manage your mutual fund portfolio

Once you determine the mutual funds you want to buy, you'll want to think about how to manage your investment.

One 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" is an investing cliche for a reason. It doesn't mean you should just stay put in a fund for life, but chasing performance almost never works out.

Frequently asked questions

Like any investment, there are good mutual funds and bad mutual funds. But overall, investors are drawn to mutual funds because of their simplicity, affordability and the instant diversification these funds offer. Rather than build a portfolio one stock or bond at a time, mutual funds do that work for you. Also, mutual funds are highly liquid, meaning they are easy to buy or sell.

All investments carry some risk, but mutual funds are typically considered a safer investment than purchasing individual stocks. Since they hold many company stocks within one investment, they offer more diversification than owning one or two individual stocks.

It's definitely possible to become rich by investing in mutual funds — many investors build their entire retirement nest egg by investing in mutual funds. Because of compound interest, your investment will likely grow in value over time. Use our investment calculator to see how much your investment could be worth as time goes on.

All investments carry some risk, and you potentially can lose money by investing in a mutual fund. But diversification is often inherent in mutual funds, meaning that by investing in one, you’ll spread risk across a number of companies or industries. Investing in individual stocks or other investments, on the other hand, can often carry a higher risk.

Time is a crucial element in building the value of your investments. If you'll need your cash in five years or less, you may not have enough time to ride out the inevitable peaks and valleys of the market to arrive at a gain. If you need your money in two years and the market drops, you may have to take that money out at a loss. Generally speaking, mutual funds — especially equity mutual funds — should be considered a long-term investment.

That really depends on your own goals, risk tolerance and the rest of your portfolio. However, to get you started, we do have a list of the best-performing mutual funds this month.

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