How to Invest in Mutual Funds
Mutual funds can be an easy addition to your portfolio that takes some of the work out of your hands as the managers of the funds handle the actual stock purchasing for you. These large investment vehicles (often worth hundreds of millions of dollars) are easy to get started in as many will allow you to buy in for as little as $100- $500. Here is a step-by-step guide on how to get started investing in mutual funds.
Decide How You're Going to BuyMany people go the route of using online brokerages to purchase mutual funds, similar to how they purchase stocks, a good guide for how to find a brokerage fund can be found here. Other avenues to purchase mutual funds are directly from the fund companies (i.e.
Understand the RisksMutual funds have varying levels of risk as some are willing to take on riskier underlying investments in order to have a chance at higher growth. Understanding the risk of the mutual fund you're investing in is important before you actually put your money down. Mutual funds that focus on small cap companies or growth markets are examples of the type of fund that is typically willing to take on higher risk. Doing some research into the mutual funds performance, it's exposure to different industries, and what the mix of underlying assets is can be very informative. Occasionally you'll find mutual funds labelled as balanced but actually having 75% of their investments in a single sector.
DiversifyAs with any form of investing you should try to diversify your mutual fund portfolio and not just hold a single one. Having a portfolio that has several mutual funds focused on different industries, regions, or equity mixes (bonds vs. stocks) will help ensure that a decline in any one of these investment types doesn't hurt your portfolio too much overall. One way many investors try to diversify is by purchasing index funds. Index funds are mutual funds that purchase bundles of stocks and try to mimic the performance of overall stock indexes like the S&P 500. In this way your risk exposure is tied to the overall ups and downs of the market, and not to any single industry.
Management FeesOne major difference you're going to want to consider is the management fees charged by the company overseeing the actual mutual fund as these can vary widely and don't always appear to reflect increased performance. You're going to want to look for the lowest management expense percentage available out of the mutual funds that you've short listed. Always keep in mind that whatever the returns you expect from the mutual fund are immediately reduced by this amount. Actively managed funds aim to generate higher returns by more regularly changing their holdings and actively responding to changes in the stock market. This comes at cost however as the management expenses for these funds are usually far higher. The alternatives are index funds (discussed above) and funds that have more of a buy and hold perspective. These funds are less actively managed and as a result tend to have lower fees attached. Historically the results of actively managed funds have not been proven to exceed those of index or less active funds.
- Try to avoid chasing performance in funds and regularly swapping in and out of mutual funds. The transaction costs usually wipe out your gains. Annual re-balancing of your portfolio is considered by most to be more than sufficient.
- Depending on your investment planning consider looking at lifecycle funds. These mutual funds follow a schedule of re-balancing that aligns with a target investor age group (riskier at the beginning and then more conservative as time goes on). These funds can make re-balancing your portfolio over time easier as the fund would align with what would be your likely risk tolerance.
- Tax advantages are certainly something you should consider when setting up your mutual fund portfolio. Purchasing mutual funds via your 401k or IRA can provide extensive tax benefits over time. Some mutual funds are also structured to minimize your tax bill through the way distributions are structured.
- Timing and distribution of payments is something you should be aware of with your mutual funds. Knowing when to expect dividends and other distributions from the mutual fund so that you can plan for them and know what you're reinvestment plan will be is important.