Mutual Fund Basics
Mutual funds are the investment of choice for many people; they allow an investor to minimize financial risk by spreading money among many different stocks and bonds, without the research and market knowledge required for such a diversified portfolio.
By diversifying their investments, they are able to invest in the stock market without taking the risks involved in having money in only one or a few companies’ stocks. Mutual funds may invest in stock of hundreds of companies, allowing the investor to spread his money around and minimize the possibility of loss. The idea is that if one company the fund invest in takes a nosedive, the other companies that are still strong will balance it out.
It doesn’t take much investment capital to get started in mutual funds; many fund companies have a lump sum requirement of one thousand to twenty-five hundred dollars, but you can often get around that with as little as fifty to a hundred dollars a month if you have it automatically withdrawn from your checking account.
The money you invest will be pooled with other investor’s money to purchase shares in the mutual fund. Investors are charged a fee based on a percentage of their investment to pay to have a professional fund manager research, buy, and sell stocks.
Fees can vary widely among different funds, it’s a good idea to carefully research any funds you’re considering, and give extra thought to funds with lower fees. A one percent difference in fees may not sound like a big deal, but over the long term it can amount to many thousands of dollars, which is extremely important when it comes to retirement planning.
Income or Growth?
There are many mutual funds available - choose a fund that serves your needs. The younger investor whose financial goal is many years away normally benefits from a growth fund. A growth fund invests in stocks in fast growing companies; the fund manager chooses investments that they believe will appreciate in value over time, making your investment worth more.
Aggressive growth funds are riskier than growth funds, but can bring bigger rewards if you are willing to ride out the ups and downs of the stock market over the long haul. Growth mutual funds are used for long range capital gains so you can one day cash in your investments for your dream home or the kid’s tuition.
Some funds are managed to provide investors with income, which may be ideal for retirees and people who need additional income. You must have investment capital to buy enough shares to make the income received beneficial to you; a small investment wouldn’t give you enough income to cover much of your living expenses.
About twenty-five thousand dollars invested in income funds would be a minimum general guideline, just to give you a rough idea, but of course, the more you have invested in income funds, the more income can be generated. Income funds invest in bonds that pay interest, and value stocks that pay dividends, which are distributed to the investor. Income funds pay out to the investor, so they won’t appreciate much in value compared to growth funds.
Some funds strive to give a combination of growth and income. They normally invest in stocks that are expected to grow, as well as bonds or stocks that pay out dividends. These funds will not grow as much as a growth fund or pay out as much as an income fund, giving you a diluted version of each.
While these types of funds may be ideal for some investors, you should carefully consider how these types of funds might affect your tax situation. You will have to pay capital gains taxes on dividends, even if those dividends are automatically reinvested. Those taxes will immediately reduce your net profit. Unless you have this type of fund for your tax-deferred retirement account, be very careful about investing in a growth and income fund, and be aware of the possible tax consequences.
Simplified, the ideal retirement strategy is to invest aggressively in growth funds in your early years and gradually shift to more conservative growth funds as you near retirement. When you’re ready to retire, you can put some of your money away very safely, such as in a money market account, and invest some of your money in income producing funds.
The key is to start your retirement planning early! A person who starts investing at a young age will have time working for them and will reap more rewards by investing far less than someone who gets into the game just a few years before retirement.
Read the Prospectus!
Different mutual funds have different goals; it’s important for you to know the objectives of any fund you choose. The prospectus gives detailed information about the fund, and should be requested before you decide to invest in that particular fund.
The prospectus will tell you about the risk involved in the fund, what fees are charged, past performance, and what types of investments are made, as well as how those assets are allocated. Past performance is not a guarantee of future performance, but it can help you spot a potential problem if that fund can’t keep up with similar funds in similar markets. Be sure to compare funds with the same objectives over a period of at least several years, and in good and bad markets.
Simply going with a fund because it’s name sounds like it’s what you need is very risky. Sometimes the name of a fund isn’t very accurate, a fund called “Growth and Income” may not provide much income at all. The prospectus will give you the important details about your investment; you should take the time to read and understand all that pertains to a fund before you commit your money to it.