What Are Mutual Funds?

If the thought of strategically investing your money for retirement sends you into cold sweats, you are not alone. There are many different investment options available, all of which carry their own benefits and drawbacks. Which is the best choice for your savings?

Mutual funds are some of the most popular and common investment tools, but it’s important to understand exactly how mutual funds work before you make your final investment decisions.

What Is a Mutual Fund?

A mutual fund is an investment that pools together the money of many different investors. Some investors might commit $5,000 while others commit $50,000. The total sum of money is invested in securities like stocks, bonds, and other assets that offer returns. You can control how your money is invested by selecting a specific type of mutual funds, such as an international stock mutual fund or bond mutual fund.

Professional money managers operate mutual funds and allocate the funds strategically to produce gains and income for all of the investors. The more you invest, the more you earn or lose based on your mutual fund’s overall performance.

How You Earn Money From a Mutual Fund

There are three different ways you may earn a return from your mutual fund investment:

First, you earn income from the dividends of stock and interest on bonds held in your mutual fund’s portfolio. It’s your choice to reinvest these earnings or receive a check for the distributions at the end of the year.

Second, you earn income any time your mutual fund secures capital gains by selling securities that have increased in price.

Third, you can earn income if your mutual fund holdings increase in price but aren’t sold by the fund manager. This makes it possible for you to sell your mutual fund shares at a higher price than you purchased them, resulting in a profit.

Different Types of Mutual Funds

Think of investing in a mutual fund like buying a car. Do you want a conservative sedan, luxurious SUV, or sports car that always drives in the fast lane? You can choose your level of risk by strategically selecting your mutual fund investment.

Low-Risk: Growth and Income
The most conservative mutual funds offer lower but steadier returns by investing in stocks from big companies like Apple and Microsoft. These large-cap funds are often used to create a stable investment foundation.

Middle of the Road
Growth “mid-cap” mutual funds use medium to large companies that are still growing. You’ll experience more market ups and downs with this type of mutual fund, but in the long run, they are known for returning higher returns.

Higher Risk: Aggressive Growth
Small-cap funds are the fast sports cars of the investing world. They come with high risks but offer higher rewards as a result. You can expect to find stocks from newer companies with excellent potential, like small tech start-ups and larger companies in emerging markets

As the name suggests, international mutual funds take a global investment approach. This doesn’t mean that you won’t recognize your investments. Even American household brands like Gerber, Frigidaire, and Trader Joe’s are foreign-owned businesses! International mutual funds give you the opportunity to benefit from the success of these corporate giants.

Starting a Mutual Fund

You wouldn’t buy the first car you see on the lot, so you shouldn’t invest in the first mutual fund you find, either. Since mutual funds always involve fees, it’s important to understand which expenses you’ll endure and how they’ll affect your profits.

To decide if a certain mutual fund is a safe place to invest your money, consider these factors:

  • What is the fund’s 10-20 year history?
  • How does the fund’s performance compare to others?
  • What fees are required?
  • What’s the minimum investment required to get started?
  • How are the funds taxed?

Some mutual funds allow investors with as little as $100, but a minimum investment of $2,500 is most common. Work with a financial professional to select a mutual fund that meets your investment needs and goals without placing your savings at unnecessary risk.

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