What Are Mutual Funds?

Mutual Funds

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

Mutual funds are some of the most popular and common investment tools. They’re also some of the safest investments since they’re composed of a basket of companies rather than just one; you won’t risk losing all your money if one company performs poorly. Instead of buying and selling individual stocks, buying and holding mutual funds composed of a basket of companies can be a safer way to watch your money grow over time. Although, it’s essential to understand exactly how mutual funds work before you make your final investment decisions.

What Is a Mutual Fund?

A mutual fund is an actively managed investment that pools together the money of many different investors. Some investors might commit $5,000 while others commit $50,000. The sum of money is invested in securities like stocks, bonds, and other assets offering returns. You can control how your money is invested by selecting a specific type of mutual fund, which I’ll describe more about below.

Professional money managers operate mutual funds and allocate the funds strategically to produce gains and income for all investors. The more you invest, the more you earn or lose based on your mutual fund’s overall performance. Professionally managed funds take the guesswork out of constantly monitoring the fund for its performance over time.

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. Here are some different types of funds:

Growth and Income Funds
The most conservative mutual funds offer lower but steadier returns by investing in stocks from big companies like Apple and Microsoft. Historically, larger companies have a good track record of reporting steady growth over time. These funds are often used to create a stable investment foundation and are usually low-risk.

Index Funds
This type of mutual fund is typically constructed to match or track components of the S&P 500, the 500 largest companies traded on the stock market in the United States. The most appealing aspects are index funds that provide broad market exposure, low operating expenses, and low company turnover. These funds are usually the core investments in 401ks and retirement accounts.

Target Date Funds
This type of mutual fund almost has its definition in its name. They’re structured to grow assets in a way that’s optimized for a specific time frame. For example, a “2060” target date fund might be a wise investment decision for a millennial-aged working individual to invest in now since 2060 is (probably) around the age they’ll want to retire. The idea is that the fund is optimized to grow in line with a target date you’ll need to access the money.

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

Mid-Cap Funds
Growth “mid-cap” mutual funds consist of medium-sized to large-sized companies that are still growing. Younger companies that are still growing can experience more volatility overall. With this type of mutual fund, you’ll experience more market ups and downs, but they are known for returning higher returns in the long run.

Small-Cap Funds
Small-cap funds are high-risk but usually come with aggressive growth. They come with greater risk but offer higher rewards as a result. You can expect to find stocks from newer companies with excellent potentials, like small tech start-ups. You can also expect high dividend payments from funds like this.

How To Choose The Best Mutual Funds For You

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 transaction fees, it’s essential to understand which expenses you’ll endure and how they’ll affect your profits.

To decide if a particular 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 are the fees?
  • What’s the investment minimum?
  • 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. My personal take? If you want to become a mutual fund investor, work with a financial advisor to select mutual funds that meet your investment needs and goals without risking your savings.

Read More: Micro-Investing: What It Is, Why It’s for You and How to Start