Your Guide to Mutual Funds

If you’ve got a bit of cash sitting in a savings account, you’ve recently landed a solid job with a paycheck that gives you room for extra savings, or you’ve started to plan for retirement, you might want to start thinking about what mutual funds to invest in.

If you’re like most people, you may not have a totally solid grasp of what a mutual fund is, or how to get started investing. Don’t worry—we’ve got you covered. Check out our guide to mutual fund investments and get your money working for you.

• What is a mutual fund?
• What are the benefits of a mutual fund?
• What kinds of mutual funds are there?
• How do I choose my funds?
• What other factors should I consider?
• Wrapping up

What is a mutual fund?

A mutual fund is an investment fund that is group-funded by many people, each of which contributes a bit of money.

The US Census Bureau reports that about half of Americans own stock in a mutual fund.

As you assess mutual fund opportunities, you need to also consider your investment portfolio. An investment portfolio is the set of stocks or bonds that your mutual fund is investing in. The kind of portfolio you’re investing in will depend entirely on what your growth strategy and timeline look like (more on that a little later), as well as your level of risk tolerance.

The takeaway here is that a mutual fund is a large investment account held by a group of people who each put in money. Your returns will depend on the amount that you put in, in addition to how well your portfolio performs. Now that you’re a step closer to understanding mutual funds, let’s find out about the benefits.

What are the benefits of a mutual fund?

There are many reasons that people invest in mutual funds, but consider these common ones, and think about whether they apply to your situation.

• Low cost: Investing can require a lot of upfront capital. However, because the best mutual funds draw on thousands of people’s investments, the large amount of capital needed to kickstart consistent growth is easily covered.
• Lower risk: Once again, there’s strength in numbers. Because there are so many people invested in the fund, and because the fund is (ideally) invested in a diverse portfolio, the risks might not be as great as betting your whole savings on that brand-new startup IPO. Think about it this way: if one of the stocks in your fund starts to dip, there are dozens of others there to pick up the slack.

• Professional management: With a busy schedule and full-time job, not everyone has the time needed to manage their own portfolios. The best mutual funds are handled by professional fund managers, so you don’t have to be worried about jumping on your computer and selling all your stock the minute you hear bad news.
• Plenty of variety: Everyone needs money for different reasons. Maybe you’re trying to save up for your first property purchase, or for retirement, or to get out of debt. Each of these needs will require totally different strategies. Luckily, there are mutual funds to invest in to meet each of them.

What kinds of mutual funds are there?

There are many different mutual funds available, but these can be generally categorized into four different areas:

Equity

This is the kind of fund you might first think of when considering investing. Equity fund portfolios buy into a number of publicly traded companies. These kinds of funds can vary based on where you want to invest, and what your level of risk tolerance is.

For instance, your portfolio might try to match the growth seen in the economy generally (that’s called a growth fund), or it might try to play the stock market a little by betting on stocks that are likely to increase. You might also want to focus on a particular industry that you believe will grow, and so your portfolio could contain stocks from multiple companies within that industry, like technology or agriculture.

Bonds

Bond mutual funds are the epitome of slow-and-steady growth, with very little risk. By investing in bonds, or in a mutual fund that invests in bonds, you are buying into somebody’s debt, most often the government or a corporation. Over time, that debt accrues interest, and that’s where your returns come from.

Because the USA is considered a stable economy that is most likely to continue to grow, government bonds from the US are a secure option for folks building up their savings. The returns will be much better than a savings account, so if you’re nervous about investing but you’re tired of seeing so little growth on your savings, you might consider bonds.

 

Money Markets

Money market funds are another option that is relatively low risk and offers slow and steady growth. They are similar to bonds, as they involve buying portions of the government’s debt. (In this case, however, it’s tied to currency commodity value.)

Another way to invest in money markets is by way of money market bank account, often advertised as a high-yield savings account. This may be a good option for those who are looking to boost their monthly interest rates but also want to maintain easy access to their cash.

Mixed Funds

This is the “all of the above” category. Many mutual funds will spread your investments across multiple sources to ensure that you enjoy the benefits of economic growth while still maintaining the safety of bonds and money markets. If you’re just getting started investing and are hoping for safe, solid long-term growth, you might consider a fund with a mixed, diverse allocation of investments.

How do I choose my funds?

The first two important things to consider before you invest your money might want to consider are time horizon and risk tolerance. A time horizon is the amount of time you have to invest, and risk tolerance is how comfortable you are with the possibility of losing some money.

The longer the time horizon, the more invested in equity funds you might want to be—after all, you’ll have more time to smooth out any bumps in the road. Bonds are often considered better for folks closer to retirement who are just trying to build up their savings.

There are also multiple different ways to invest.

• You could walk into a brick-and-mortar investment office and talk with a broker about your financial plans. They’ll be able to set you up with the kind of account that works best given your risk tolerance and time horizon.
• You could also consider a “robo-investor” tool. There are a number of apps that offer algorithmic investment, typically in growth funds, at much lower rates than a human broker can offer. This can be a particularly good option for people who are investing long-term.
• You might consider researching funds that have done particularly well over the past five years. News about the performance of mutual funds is readily available online and could provide you with good options for your first investment.

What other factors should I consider?

Consider why you want to invest in a mutual fund. For many, the reason is retirement. The earlier you start saving for retirement, the better off you’ll be in the long run. As your money makes more money, that new total may make even more money as it accrues interest.

Retirement accounts are built for slow and steady growth, at very low risk. (Many employers offer 401k retirement accounts, and some offer employer-matched 401ks. That means your employer will match the monthly contribution you’re making to your own 401k. If your employer offers one, consider taking advantage of it.)

However, you might also be hoping for a more aggressive strategy for the short-term. Maybe you’re trying to buy property soon, and you need a fund to get you to your savings goal ASAP. You might want to consider short-term or high-yield funds for this goal.

You might also be somewhere in the middle and are just hoping to boost your net worth with an investment account that grows in step with the economy. There are three important variables you’ll want to consider before investing in a fund, no matter what your purpose is:

1. Average annual return: Check out the average annual return over the past five or so years to see if the fund has historically performed well. This will give you a good indication of the amount of money you can expect to earn on your investments.
2. Diversity: The key to sustainable growth is maintaining diversity in your portfolio. A mutual fund that’s gone all-in on one stock is particularly risky. Even if you are risk-tolerant, be sure that you’re checking out how diverse a portfolio is before investing.
3. Fees and expenses: You may want to review a number of different funds and brokers before committing to one that looks appealing, as many funds come with fees and other various expenses.

Once you’ve settled on your financial goals and have assessed your risk tolerance, it’s time to think about finding the best mutual funds to suit your goals and preferences.

Wrapping up

No matter your age or career, investing in mutual funds may be a good idea if you do it wisely. And if you’re worried about all the jargon and complicated concepts, check out Investor.gov, for some excellent information for first-time investors.

By researching investing and looking up mutual funds definitions, you’re already making a great first step! You may want to take some time and reflect on your financial situation, as well as your short-term and long-term goals, and then consider if mutual fund investments are right for you.