How to Invest in Mutual Funds

Mutual funds are an important part of investing in the stock market. While you can buy and sell individual stocks directly, that can come with a higher risk (and a higher potential reward). When you buy and sell shares in one individual stock, your performance is tied solely to the performance of that stock and company. In the absolute worst-case scenario, if you invest all of your money in one company’s stock, and the stock price goes to $0, you will end up losing everything.

The good news for investors is that mutual funds can hopefully be a way to reduce your risk and still capture a good chunk of the potential investment return. In this article, we’ll talk about what mutual funds are, how to select the right mutual fund for you and how to get started. 

Active vs. Passive Mutual Funds

Before talking about why you should consider investing in mutual funds, it’s a good idea to take a step back and understand that there are actually two main kinds of mutual funds:

• Active mutual funds — active mutual funds usually have a professional advisor, team or company that actively manages the fund. While the fund may have a stated goal roughly detailing the type of investments the fund invests on, the fund managers will make the day-to-day decisions about what investments to make and when to buy and sell.
• Passive mutual funds — passive mutual funds are generally tied to mirror a specific index or benchmark. Index funds and exchange-traded funds (ETFs) are two common kinds of passive mutual funds.

While there can be reasons to invest in both active and passive mutual funds, it’s important to note that active mutual funds usually come with higher fees than passive mutual funds.

Why You Should Invest in Mutual Funds

One of the biggest reasons to invest your money in mutual funds is to spread out your risk. As we mentioned earlier, if you have all of your investment dollars in one company’s stock, you run the risk of that company’s stock going to $0, causing you to lose all of your money. Another related reason to invest in mutual funds is to increase your diversification. Mutual funds often invest in hundreds if not thousands of different stocks, bonds and other types of investments.

How to Select The Right Mutual Fund For You

There are many kinds of mutual funds out there, so you may wonder what are the best mutual funds or how to choose a mutual fund. There isn’t a single best mutual fund that is the right decision for everyone. Instead, what might be the right mutual fund for some people may not be the right mutual fund for you, depending on your own unique financial situation. When choosing a mutual fund, two things that you’ll want to consider is your time horizon and your individual risk tolerance.

Your time horizon is roughly defined as the length of time until you’ll need the money that you are investing today. If you’re in your 20s and investing for retirement, you may be willing to accept more risk, since you might have 40 years or more until you’ll need the money. With that much time, the long-term upward trajectory of the overall market is likelier to make up for any short-term losses. On the other hand, if you’re investing to save up for a down payment on a house or for your kids’ college, you may want to take fewer risks. 

Your individual risk tolerance speaks to how comfortable you are with risk. If you have a solid grasp of how the stock market works and are comfortable with short-term losses, you might be willing to select a mutual fund with higher average returns and higher potential short-term losses. If the thought of losing any money causes you stress and worry, you might want to choose a mutual fund that minimizes losses, even at the expense of a higher overall return.

Getting Started Investing in Mutual Funds

The great news if you’re wanting to get started investing in mutual funds is that it is quite easy. You can open an account at any number of online brokerages, and most of them will support buying and selling mutual funds. Once you have identified the mutual fund or funds that you want to invest in, just find its ticker symbol. Then you can enter that in on your brokerage and you’ll be well on your way to investing in mutual funds.

The Bottom Line

At its core, a mutual fund is just a collection of different stocks, bonds or other investments. Mutual funds can provide a bit more diversification and hopefully risk mitigation than simply investing in individual stocks. There are two main categories of mutual funds — active mutual funds and passive mutual funds. Active mutual funds are actively managed by an individual, group or company and usually come with higher fees. Passive mutual funds are often tied to mirror a specific index or benchmark. Once you’ve found the right mutual fund for you, you can start investing in mutual funds through your choice of brokerage.