In today’s high-tech environment, no matter what kind of investment vehicle you choose, investing has never been easier. The downside is that it also may have never been more confusing. With all the information available at your fingertips, it’s easy to get overwhelmed by the sheer number of choices available to you.
Many financial experts advocate for investing in mutual funds as a sound, long-term retirement strategy. What are they, and how can they benefit you? If you’re puzzled by those questions, keep reading as we show you how to invest in mutual funds and more.
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What are Mutual Funds?
Mutual funds come into being when a collection of investors with smaller amounts of capital consolidate their money. They then engage a financial professional to manage their “mutual” portfolio. These funds are designed as alternatives for investors who don’t necessarily have the asset allocation to merit a full individual portfolio. As returns are realized, each individual investor receives a piece of the overall “pie” that is in proportion to his/her investment in the complete portfolio. Investors share expenses across the portfolio. Basically, by investing in a mutual fund, you get all the full benefits of diversification while sharing only a fraction of the associated costs.
Once you receive your piece of the pie, it can be reinvested in the income fund. This can lead to a larger slice of pie for you during the next period. You keep doing this over time to build your nest egg. The most important thing is being willing to walk away and leave your money, letting it continue earning interest over time. In fact, some experts say that how long you leave your money in your mutual fund is a more important factor than which funds you invest in. A buy-and-hold strategy has historically served investors best when it comes to meeting long-term goals.
Sometimes referred to as the “big-box store of investing,” mutual funds bundle a wide range of investment products. You can then purchase these for one price instead of working with individual stocks. They give you the ability to invest in many different companies at once. If you’re already enrolled in an employer-sponsored 401(k), that’s an easy place to get started with mutual fund investing.
Mutual funds come in several varieties, including those that focus on particular asset classes. Those that are designed to mimic an index (you’ll see these called index funds), and those that focus on dividend stocks. Mutual funds can also be structured in several different ways, including closed and open-end funds.
On the most general level, you can find mutual funds in three major categories. The categories are equity or stocks, fixed income or bonds, and money markets, which are similar to cash. Equity and fixed-income funds also have sub-categories that allow investors to choose specific companies that resonate with them. For example, an investor might want to choose eco-friendly companies or companies with a service component. Or you might want to pick a fund that only invests in government securities.
Why Should You Invest in Mutual Funds?
Financial and investment management experts tout mutual funds as one of the very best investment vehicles. They allow you the full benefits of diversification at a lower investment level. Your investment is split among a diverse portfolio of companies and industries. Therefore, you don’t have to worry about your whole account tanking because of volatility in one market or within one industry or company.
Mutual funds also have a good history of solid returns over time. Keep in mind that that doesn’t guarantee large short-term capital gains every earnings period. However, data shows that mutual funds are a solid choice that delivers good returns for mutual fund investors in the long-run. You have to keep your money in long enough to ride out dips in the market. The S&P 500 is a great example. It tracks the stock market performance of the 500 largest and most stable companies across the nation. Since its creation in 1923, it has averaged a 12 percent annual return.
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How Much Money Do You Need to Have to Invest in Mutual Funds?
The great thing about mutual fund investment is that it opens doors for investors with smaller deposits to get some of the benefits of diversification that more affluent investors have long enjoyed, but with lowered expenses. Exactly how much you need to start with depends in large part on the brokerage partner you choose. Many companies have account minimums that you need to reach in order to open an account.
Here’s something to consider, though: some financial and investment management experts advocate for investing 15 percent of your annual income in your retirement account. That’s a number to work toward if you’re not already there. Keep in mind that at that the end of the day, building wealth takes consistency and discipline. Even if you can’t carve out 15 percent, pick out a percentage of your income that’s doable. You can have it automatically contribute to your retirement plan. Then make sure to add to it at regular intervals over time until you eventually reach that 15 percent mark or higher. Then, keep investing consistently – no matter what the market is doing.
How Do You Choose Which Mutual Fund is Right For You?
You’ll want to consider several factors as you choose which kind of mutual fund you’d like to invest in. Perhaps the most important factor is your risk tolerance and your overall investment goals. In fact, before you make any kind of investment, you should be clear about how much risk you’re willing to expose yourself to. That way, you can seek out a mutual fund that syncs with your comfort level and risk tolerance. If you know where you want to end up, you can be intentional about pairing yourself with a fund that can help you reach your investment goals. At the same time, staying within the parameters of risk tolerance that you’ve previously set.
Some financial experts recommend the strategy of actually investing in four different types of mutual funds. You can spread your investment allocation equally among the four types. Doing this helps keep you insulated against volatility in the market. If you have four different types, and one is performing poorly, chances are at least one or two of the others should be performing well. An ideal mix of four mutual funds may look like the following:
Growth and Income
These are stable, well-performing (okay, and maybe a little boring) domestic companies that are experiencing growth. They create a stable foundation for your portfolio. You’ll see these kinds of mutual funds described as large-cap, large-value, blue-chip, dividend income, or equity funds.
This group usually features mid-size to large U.S. companies that are currently experiencing growth. You’ll see these funds move in tandem with the market more so than the previous group of funds. You’ll see this category of mutual funds described as equity, growth, or mid-cap funds.
Just like it sounds, this category is a little bit of a wild card. You might see wild swings between high and low performance for this category. These are usually smaller companies or larger companies that are investing in emerging markets. You’ll often see them described as small-cap.
International funds are a good insurance policy against the volatility of the U.S. market. You’ll often see these referred to as oversees or foreign funds. Investing internationally may also allow you to invest in big-name, non-American companies that you know and love.
Be careful, though, not to confuse international funds with global funds. These bundle U.S. and foreign companies together within a fund.
Step-by-Step Guide to Investing in Mutual Funds
Buying into a mutual fund is quite different from purchasing stocks. Whereas stocks are sold in individual shares, mutual funds are sold as dollar amounts. You can buy them directly from mutual fund companies. Or, you can choose to go through a financial adviser, a brokerage, a bank, or any other financial institution with which you have an account.
Choose Active or Passive
You can invest in mutual funds in one of two ways – active or passive. An active investor is one who is actively trying to beat the market. This investor will research everything she can and try to invest with an eye toward getting a better return than the market. A passive investor, on the other hand, is more interested in mimicking the market than besting it. A passive approach involves taking a much more hands-off strategy, often by investing in index funds.
Keep in mind that most financial professionals agree that, over time, it is very difficult to beat the market. Some actively managed funds may deliver in the short-term, but they rarely hold up over time. Additionally, actively-managed funds carry higher fees because of the higher level of human interaction involved. Passive investing, on the other hand, continues to grow in popularity – largely because it’s easy and because it delivers superior results. It also brings with it fewer expenses.
The easiest passive investing is the index fund. This bundles a collection of securities that represents the entirety of the market, so the fund’s performance will naturally mimic that of the overall market. That means that since you don’t have to have a financial professional reallocating or adjusting those securities for you, your fees will naturally be lower, and funds that mimic the market tend to perform better over time.
Establish Your Investment Budget
Remember that your goal in setting up your mutual fund is to let your money grow over time. If you don’t think you’ll be able to go at least five years without accessing those funds, then you may not get your money’s worth. Decide how much money you can put aside without needing to access so that it can continue to earn investment returns for you until you need it.
Some mutual fund providers have a minimum required deposit to set up an account. Those minimums often range anywhere from $500-$3,000.
Pick Your Fund
You’ll first need to choose an initial mix of funds. Generally speaking, the closer to retirement you are, the more conservative you’ll want your asset management to be. Those farther away from retirement have the luxury of time to ride out any riskier investments. Some funds make it easy for you by giving you target date choices – you just pick the fund that lines up with your target retirement date, and it will rebalance and adjust your asset allocation over time to meet that goal.
Pick a Broker
You can buy a mutual fund directly from the company that created the fund. Vanguard or BlackRock Funds, for example, are great companies to start with. Or, you can work with a financial adviser or broker to set up your fund. A good rule of thumb is to go with an online brokerage account. They usually have a broad selection and offer some helpful tools as well. If you decide to go with a broker, here are some additional points to consider:
If you’re invested in an employer-sponsored 401(k), you might have access to a few mutual funds. However, the selection is usually quite limited. Still, an online brokerage account might offer as many as thousands of no-fee mutual funds you can choose from. You can typically find a good selection of target-date funds through an online broker as well.
If you invest in a mutual fund, you can expect two types of fees: transaction fees and sales loads. Look for a brokerage partner that helps you keep as much of your investment earnings as possible in your pocket.
Ease of Use
Your online broker’s website should be intuitive and user-friendly. Investing can be complicated enough without layering in confusion from complicated technology. Make sure you’re comfortable with the overall user experience and feel good about using your partner’s digital platform.
Educational Tools and Research
The right kind of broker will want to help you become a savvier investor. They’ll offer plenty of educational materials and research from reputable and reliable sources that can help you make more sound investment decisions. Unless you just want to be completely hands-off, it behooves you to find a partner that will help educate you and make you a better investor rather than simply take your money.
Get Clear on Fees
As long as you have an account with a financial institution that offers mutual funds, you can purchase from them. You can choose a fund that’s either “load” or “no-load.” This is just a complicated way of indicating whether the fund will charge you a commission. If you’re working with a professional financial adviser, chances are pretty good that you’ll be purchasing a load fund. However, don’t be fooled into thinking that because you choose no-load mutual funds, that means they’re free. All mutual funds have some level of internal expenses associated with them.
Some level of your investment earnings will go toward paying the fund manager, the company, and any other fees associated with managing your funds. These fees are typically clearly communicated to you and can be taken from the assets associated with your account. Just make sure you’re clear on exactly the type and level of fees and expenses you’ll be charged before you set up your account.
A company generally will charge you an annual fee to manage your fund. This is expressed as a percentage of the money you invest. This is called your expense ratio. To illustrate, a fund with an expense ratio of 1 percent will charge you $10 for every $1,000 you’ve invested.
Reach Out and Open Your Account
The actual setting up of a mutual fund account is fairly quick and simple. You can do it over the phone or online. If you prefer to work with a financial professional, you can always set up a face-to-face meeting to do your setup. You simply need to indicate how much you’d like to invest and which mutual fund(s) you’d like to purchase. The closing share price at the end of that day will determine the price you’ll pay for your shares.
Manage Your Account Over Time
How you manage your account is completely up to you and your level of comfort between passive and active investing. For example, if you’ve invested in a target-date fund, you don’t really have to do anything. Your fund will automatically rebalance in line with your retirement goals. But if you’re a little more hands-on, you might consider working with a financial professional. They examine and potentially rebalance your portfolio once per year to make sure it’s in line with your goals and your retirement plan.
In general, it’s a good idea to rebalance your fund no more than once per year. This can keep you from falling into the fool’s game of chasing short-term performance.
To Sum it Up
Mutual funds are solid investment tools that can help you build a nice nest egg. Don’t get intimated and give up on them before you even start. Do your research and partner with a professional if you still feel unsure. Alternatively, you can buy a target-date fund from an online brokerage you feel good about and let them manage it for you over time. The important thing is to get started. Don’t let fear about the complexities of investing keep you from building appropriate wealth for tomorrow.
What kind of mutual funds have you bought? Tell us about your experience below.