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Jun252014

09:06:13 pm

What Are Mutual Funds? - Yahoo Voices

Mutual funds are a common and popular form of investment for savers looking to earn a higher return on investment compared to treasuries, bonds, and bank CDs. Mutual Funds work by pulling together investors money (the money you and other investors give to them) and investing them in stocks (equities). The number of stocks and type of stocks a mutual fund is invested in will vary from fund to fund. Typically a mutual fund will have a particular focus such as precious metals or large US companies (large Cap US). A precious metal mutual fund will target ownership of gold and silver mining companies and may even have a portion of its funds invested in gold or silver. Where as a mutual fund focused on large Cap US stocks will have its funds invested in the 500 largest US stocks or perhaps the largest 100 US stocks. Other types of mutual funds will target medium sized US stocks (mid Cap), small US stocks (small Cap), total stock (a blend of large, mid, and small Cap), international stocks (non US stocks), or may target a particular sector such as real estate stocks (REITs) or healthcare stocks. So essentially a mutual fund works by taking the money you and others give them and invest it in a particular class or type of stocks.

The benefit of holding a mutual fund is diversity in your portfolio. Diversity can be useful because it will spread out your risk and the value of your investment will not depend on the performance of one particular stock. Many investors make the mistake of exclusively investing in the company they work for. No matter how stable a company may seem investing a large portion of your life savings in one company is a bad idea. Consider those who worked for General Motors. The value of General Motors went from $38.07 a share in June 2007 to $1.00 a share in June 2009! This would be a tremendous loss to any investor and General Motors was a company that was supposed to be stable and the stock was considered safe! The most recent downturn reminded many investors having your life savings invested in one company is very risky and is not a good idea. Almost every stock fell during the most recent downturn but many of these stocks have rebounded but some went bankrupt. If you were unfortunate to have ownership in a stock that went bankrupt, you lost every penny. Whereas if you own a mutual fund, some of the stock holdings may have gone bankrupt, but the beauty of mutual funds is that they are formulated so that no single holding will bring down the entire fund.

The way mutual funds make money are by charging various fees. The fees come in the forms of a purchase fee, a redemption fee, and expense ratios. A purchase fee (also known as a front end load) is charged when buying a particular fund, for example a 0.25% purchase fee may be enforced when you decide to purchase a mutual fund. The way this works is that 0.25% of your total investment goes towards paying for the privilege of purchasing the fund (avoid purchase fees if you can, for every $10,000 investment you make $25 is taken away: your net investment is only $9,975). A redemption fee (also known as a back end load) is charged when you sell a particular mutual fund you will receive the full value of your mutual fund minus a surcharge (again suppose 0.25%, where for every $10,000 worth of mutual funds you sell you only get $9,975. Again avoid these fees if possible). The last type of fee is an expense ratio fee. The expense ratio fee is assessed when dividends or capital gains are distributed to mutual fund holders. This particular fee will go towards the maintenance cost of the fund and paying for the salaries of the fund's managers. Expense ratios can vary drastically from fund to fund (again you want to minimize the expense ratio when you choose a fund).

Now that you know what a mutual fund is, how they work, and how mutual fund managers make their money you are almost ready to make a decision on what type of mutual fund is right for you. You still have one last important question to answer. What is the right type of mutual fund to invest in, should you go with a large Cap, mid Cap, small Cap, a total stock fund, an international fund, or target a specific sector? Well this is up to you, I would recommend talking to a financial planner or a mutual fund advisor, My two cents is that you are better off going with the most diverse fund available and mixing up. A large portion of your funds should be comprised of a total stock fund and you should also have a substantial holding in an international stock fund. A thing to keep in mind is that mutual funds are a long term investment and that you should never hold all of your savings in a mutual fund. I recommend anywhere from 50-90% for a young investor far away from needing the funds to 10-40% for investors near or in retirement. Overall mutual funds are a great way to invest as they offer you the growth potential of individual stocks yet are much safer than owning individual stocks. One thing to keep in mind is that mutual funds will vary in performance and experience rapid fluctuations especially in times of economic hardship. Do not invest in mutual fund if you plan on using the money within a 5 year period. Good luck and one last word, talk to your financial planner or advisor about how mutual funds may work for you.


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