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Mutual Fund Investing Basics – A Brief Overview Of Mutual Funds

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Introduction

 

 

We are about to embark on yet another part of your investing journey here at Invest In Wall Street – that being Mutual Funds & ETFs. I know that many of you have at least heard about them once are twice – as they are often brought up on occasion, especially if you are relatively new to investing. Mutual Funds and ETFs both have two things in common, they offer the investor a widely diversified portfolio, and are considered to be relatively low risk investments – but this isn’t to say that these assets aren’t without risk – as all financial investments come with some form of risk.

But lets not get too ahead of ourselves. We will take things one at a time – and in this lesson, we will explain the mutual fund investing basics that every rookie investor should know.

Whether you are looking to invest in mutual funds or are curious to what they may entail, we will be answering these questions and more over the course of this module.

 

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

Mutual Fund Investing Basics

 

A mutual fund is a collective investment that pools together the money of a large number of investors to purchase a variety of securities, like stocks and bonds.

When you purchase a share in a mutual fund, you have a small stake of all investments included in that fund.

Think of a mutual fund like a basket of investments. When you purchase a share in a mutual fund, you are buying one share of this basket and therefore, have a stake in one small fraction of all the investments in that fund.

 

 

Mutual funds can potentially benefit investors in several ways. They’re a way to make a diversified investment.

Most are managed by financial professionals, and because of the wide variety of mutual funds, they allow investors to participate in a wide variety of investment types.

 

 

Let’s walk through an example of how a mutual fund works.

Suppose there is an investor who wants to invest some of their retirement portfolio in the stock market, but they don’t have time to analyze individual stocks and create a diversified stock portfolio.

Instead, they decide that they would rather purchase a mutual fund. This way, the investor can make a single investment, which will be similar to purchasing an entire portfolio of stocks.

But which mutual fund is right for them?

How To Find The Right Mutual Fund

 

To find the right one, they can use online tools, such as mutual fund searches and ratings given by independent third party organizations to find a mutual fund that meets their investing goals. Once they find a fund that looks like a good fit, they can then review the fund’s prospectus, which is the official summary and explanation of how the fund operates.

The prospectus provides a variety of information about the fund, including its fees and charges, minimum investment amounts, performance history, risks, and other useful information.

After researching the fund and its prospectus, our investor decides that this fund looks like a good investment, so they buy the minimum required investment amount and purchases shares of the mutual fund.

By owning shares, the investor now participates in the gains and losses of all companies held in the fund.

The benefit of this, of course, is diversification, which is when an investment or portfolio is spread across several different investments – as doing this can help lower risk.

 

 

For example, if one company that the fund invests in has a rough year, the impact of the fund’s total assets can be small because that struggling company is only one fraction of the fund’s total assets.

Like most other mutual funds, the fund the investor chose is actively managed, meaning it is run by a fund manager or managers who buy and sell the fund’s assets. Fund managers aim to provide the biggest returns they can for investors by using financial analysis and professional expertise.

While a talented manager could earn good returns for the investor’s fund, there is no guarantee of success. If a manager makes choices that don’t pay off, our investor won’t earn the returns they were hoping for.

However, even if the fund doesn’t perform well, the manager still collects a fee, which is paid from the fund’s assets -meaning even lower returns.

 

 

Management fees aren’t the only costs our investor has to pay, either. Besides transaction fees, the fund may have a sales load, which is a charge to either buy or sell shares. Some funds also charge an additional load if shares are sold within a specific time frame.

Now that our investor has bought into a fund, how might they make money from it?

Breaking Down Mutual Fund Profits

 

One way is through appreciation, which is when the fund’s shares go up in value. Typically, when the fund’s assets rise in value, the fund’s shares do the same.

Unlike a stock, the value of a fund’s shares does not change throughout the trading day. Instead, the fund’s value is calculated and updated when the market closes.

Another way an investor might make money through a mutual fund is from a dividend payment, which is when a mutual fund pays out a portion of it’s earnings to shareholders.

However, when the fund’s assets fall in value, the fund’s shares do the same, which is a risk of owning a mutual fund

 

 

One benefit to mutual funds is the variety of mutual funds available – there is a mutual fund for almost every type of investment.

For example, equity funds buy stocks, fixed income funds buy bonds, and balanced funds buy both. Some mutual funds may invest in a whole index, while some others focus on stocks for a certain country or market sector.

Certain funds have different objectives as well. Some may look for riskier stocks in growing countries while others invest in more stable companies.

There is a lot to learn about mutual funds and other investment options, and we’ve got the resources to help you get started here at Invest In Wall Street.

 

Quick Recap

In Review….

Mutual Funds

  • A mutual fund is a collective investment that pools together the money of a large number of investors to purchase a variety of securities, like stocks and bonds
  • When you purchase a share in a mutual fund, you have a small stake of all investments included in that fund
  • Think of a mutual fund like a basket of investments. When you purchase a share in a mutual fund, you are buying one share of this basket and therefore, have a stake in one small fraction of all the investments in that fund
  • Mutual funds can potentially benefit investors in several ways. They’re a way to make a diversified investment
  • Most are managed by financial professionals, and because of the wide variety of mutual funds, they allow investors to participate in a wide variety of investment types
  • The benefit of this, of course, is diversification, which is when an investment or portfolio is spread across several different investments – as doing this can help lower risk. For example, if one company that the fund invests in has a rough year, the impact of the fund’s total assets can be small because that struggling company is only one fraction of the fund’s total assets
  • Like most other mutual funds, the fund the investor chose is actively managed, meaning it is run by a fund manager or managers who buy and sell the fund’s assets. Fund managers aim to provide the biggest returns they can for investors by using financial analysis and professional expertise
  • While a talented manager could earn good returns for the investor’s fund, there is no guarantee of success. If a manager makes choices that don’t pay off, our investor won’t earn the returns they were hoping for
  • However, even if the fund doesn’t perform well, the manager still collects a fee, which is paid from the fund’s assets-meaning even lower returns
  • Management fees aren’t the only costs our investor has to pay, either. Besides transaction fees, the fund may have a sales load, which is a charge to either buy or sell shares. Some funds also charge an additional load if shares are sold within a specific time frame
  • One benefit to mutual funds is the variety of mutual funds available – there is a mutual fund for almost every type of investment. For example, equity funds buy stocks, fixed income funds buy bonds, and balanced funds buy both. Some mutual funds may invest in a whole index, while some others focus on stocks for a certain country or market sector
  • Certain funds have different objectives as well. Some may look for riskier stocks in growing countries while others invest in more stable companies

Mutual Fund Research

  • To find the right one, they can use online tools, such as mutual fund searches and ratings given by independent third party organizations to find a mutual fund that meets their investing goals. Once they find a fund that looks like a good fit, they can then review the fund’s prospectus, which is the official summary and explanation of how the fund operates
  • The prospectus provides a variety of information about the fund, including its fees and charges, minimum investment amounts, performance history, risks, and other useful information
  • After researching the fund and its prospectus, our investor decides that this fund looks like a good investment, so they buy the minimum required investment amount and purchases shares of the mutual fund
  • By owning shares, the investor now participates in the gains and losses of all companies held in the fund

Investors Earn Profits In 2 Ways…..

  1. Growth & Appreciation – The underlying assets within the fund must increase in value. Typically, when the fund’s assets rise in value, the fund’s shares do the same
  2. Dividends – When a mutual fund pays out a portion of its earnings to shareholders

 

 

And this has been a brief overview of mutual funds. A mutual fund pools money from investors to invest in a specific group of assets classes. These funds are managed by financial managers and therefore, require you to pay a management fee for their services. Keep in mind that there are other fees that may be involved in owning a mutual fund – which should be clarified with your portfolio manager.

Unlike mutual funds, who’s shares prices are regulated periodically throughout the day. The valued price of mutual funds are calculated after the stock market has closed and therefore, can not be traded.

Mutual funds are considered to be great investments that offer the investor the aspect of diversification – as this can save you the energy required to research and create a well-developed stock portfolio. However, the extra fees may chip in to your profits – and in the next few lessons, we will be discussing the various fees associated with owning a mutual fund, along with how you can reduce these monthly fees.

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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